**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 
| **(Mark One)**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        | ** ** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| **ý****Quarterly Report Pursuant to Section 13 or 15(d) of the Securities  Exchange Act of 1934**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |       |       |
| **for the quarterly period ended September 30, 2005.**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| **Or**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |       |       |
| **o****Transition Report Pursuant to Section 13 or 15(d) of the Securities  Exchange Act of 1934**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| **for the transition period  from                                                        to                                               ** |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |       |       |
| **Commission File Number 000-50266**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  | ** ** | ** ** |

 

**TRINITY CAPITAL CORPORATION**

(Exact name of registrant asspecified in its charter)

 
| **New Mexico**                                        |       | **85-0242376**                          |
|-------------------------------------------------------|------------|-----------------------------------------|
| (State of incorporation)                              | ** ** | (I.R.S. Employer Identification Number) |
|                                                  |       |                                    |
| **1200 Trinity Drive, Los Alamos, New Mexico  87544** |
| (Address of principal executive offices)              |
|                                                  |       |                                    |
| **(505) 662-5171**                               |
| Telephone number                                      |

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.  Yes ýNo o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Securities Exchange Act of 1934).  Yes ýNo o

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act).  Yes oNo ý

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date: 6,630,378 shares ofcommon stock, no par value, outstanding as of October 27, 2005.

 

 

----

 

**TRINITY CAPITAL CORPORATION AND SUBSIDIARIES**

 
| ** ** | **PART I.  FINANCIAL INFORMATION**                                                     | ** ** |
|------------|---------------------------------------------------------------------------------------------|------------|
| ** ** | ** **                                                                                  | ** ** |
| Item 1.    | Financial  Statements                                                                       |       |
| Item 2.    | Management’s Discussion and  Analysis of Financial Condition and Results of Operations |       |
| Item 3.    | Quantitative  and Qualitative Disclosures About Market Risk                                 |       |
| Item 4.    | Controls and  Procedures                                                                    |       |
|       |                                                                                        |       |
| ** ** | **PART II.  OTHER INFORMATION**                                                        |       |
| ** ** | ** **                                                                                  |       |
| Item 1.    | Legal Proceedings                                                                           |       |
| Item 2.    | Unregistered  Sales of Equity Securities and Use of Proceeds                                |       |
| Item 3.    | Defaults  upon Senior Securities                                                            |       |
| Item 4.    | Submission  of Matters to a Vote of Securities Holders                                      |       |
| Item 5.    | Other Information                                                                           |       |
| Item 6.    | Exhibits                                                                                    |       |
|       | SIGNATURES                                                                                  |       |

 

1

----

 

**PART I – FINANCIAL INFORMATION**

 

**Item 1.  FinancialStatements**

 

**TRINITY CAPITAL CORPORATION &SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

**September 30, 2005 and December 31,2004**

**(Amounts in thousands, except share data)**

 
| ** **                                                                                                                                                                                                                                                                                                                                                  | ** ** | **September  30, 2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                                                  | ** ** | **(Unaudited)**         | ** ** | ** **             | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                                                                                                                  | ** ** | ** **              | ** ** | ** **             | ** ** |
| Cash and due  from banks                                                                                                                                                                                                                                                                                                                                    |       | $                       | 23,691     |                   | $          | 23,678 |   |
| Interest  bearing deposits with banks                                                                                                                                                                                                                                                                                                                       |       | 62,211                  |       | 96                     |       |
| Federal  funds sold and securities purchased under resell agreements                                                                                                                                                                                                                                                                                        |       | 655                     |       | 40                     |       |
| **Cash and cash equivalents**                                                                                                                                                                                                                                                                                                                               |       | $                       | 86,557     |                   | 23,814     |   |
| Investment  securities available for sale                                                                                                                                                                                                                                                                                                                   |       | 40,760                  |       | 44,105                 |       |
| Investment securities held to maturity, at  amortized cost (fair value of $32,846 at September 30, 2005 and $61,883  at December 31, 2004)                                                                                                                                                                                                        |       | 32,880                  |       | 61,658                 |       |
| Other  investments                                                                                                                                                                                                                                                                                                                                          |       | 8,008                   |       | 7,480                  |       |
| Loans (net of allowance for loan losses of  $9,850 at September 30, 2005 and $8,367 at December 31, 2004)                                                                                                                                                                                                                                         |       | 995,647                 |       | 885,954                |       |
| Loans held  for sale                                                                                                                                                                                                                                                                                                                                        |       | 15,666                  |       | 8,634                  |       |
| Premises and  equipment, net                                                                                                                                                                                                                                                                                                                                |       | 24,700                  |       | 25,450                 |       |
| Accrued  interest receivable                                                                                                                                                                                                                                                                                                                                |       | 6,282                   |       | 5,941                  |       |
| Mortgage  servicing rights, net                                                                                                                                                                                                                                                                                                                             |       | 8,921                   |       | 8,371                  |       |
| Other real  estate owned                                                                                                                                                                                                                                                                                                                                    |       | 330                     |       | 6,438                  |       |
| Other assets                                                                                                                                                                                                                                                                                                                                                |       | 3,115                   |       | 2,548                  |       |
| **Total assets**                                                                                                                                                                                                                                                                                                                                            |       | $                       | 1,222,866  |                   | $          | 1,080,393 |   |
|                                                                                                                                                                                                                                                                                                                                                        |       |                    |       |                   |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                                                                                              |       |                    |       |                   |       |
| Liabilities                                                                                                                                                                                                                                                                                                                                                 |       |                    |       |                   |       |
| Deposits:                                                                                                                                                                                                                                                                                                                                                   |       |                    |       |                   |       |
| Noninterest bearing                                                                                                                                                                                                                                                                                                                                         |       | $                       | 92,392     |                   | $          | 63,070 |   |
| Interest bearing                                                                                                                                                                                                                                                                                                                                            |       | 929,161                 |       | 817,511                |       |
| **Total deposits**                                                                                                                                                                                                                                                                                                                                          |       | 1,021,553               |       | 880,581                |       |
| Short-term  borrowings                                                                                                                                                                                                                                                                                                                                      |       | —                  |       | 34,400                 |       |
| Long-term  borrowings                                                                                                                                                                                                                                                                                                                                       |       | 84,261                  |       | 60,006                 |       |
| Junior  subordinated debt owed to unconsolidated trusts                                                                                                                                                                                                                                                                                                     |       | 32,992                  |       | 22,682                 |       |
| Borrowings  made by Employee Stock Ownership Plan (ESOP) to outside parties                                                                                                                                                                                                                                                                                 |       | 1,214                   |       | 1,686                  |       |
| Accrued  interest payable                                                                                                                                                                                                                                                                                                                                   |       | 3,368                   |       | 2,768                  |       |
| Other  liabilities                                                                                                                                                                                                                                                                                                                                          |       | 3,229                   |       | 5,314                  |       |
| **Total liabilities**                                                                                                                                                                                                                                                                                                                                       |       | 1,146,617               |       | 1,007,437              |       |
| Stock owned by Employee Stock Ownership  Plan (ESOP) participants; 622,239 shares and 636,915 shares at  September 30, 2005 and December 31, 2004, respectively, at fair  value; net of unearned ESOP shares of 73,347 and 98,318 shares at  September 30, 2005 and December 31, 2004, respectively, at  historical cost |       | 16,316                  |       | 18,078                 |       |
| Commitments  and contingencies                                                                                                                                                                                                                                                                                                                              |       |                    |       |                   |       |
| Stockholders’  equity                                                                                                                                                                                                                                                                                                                                  |       |                    |       |                   |       |
| Common stock, no par, authorized  20,000,000 shares; issued 6,856,800 shares, shares outstanding  6,630,378 and 6,732,748 at September 30, 2005 and December 31,  2004, respectively                                                                                                                                                    |       | 6,836                   |       | 6,836                  |       |
| Additional paid-in capital                                                                                                                                                                                                                                                                                                                                  |       | 1,098                   |       | 997                    |       |
| Retained earnings                                                                                                                                                                                                                                                                                                                                           |       | 56,215                  |       | 47,849                 |       |
| Accumulated other comprehensive (loss)                                                                                                                                                                                                                                                                                                                      |       | (236                    | )          | (200                   | )          |
| Total stockholders’ equity before treasury  stock                                                                                                                                                                                                                                                                                                      |       | 63,913                  |       | 55,482                 |       |
| Treasury stock, at cost, 153,075 shares and  25,734 shares at September 30, 2005 and December 31, 2004,  respectively                                                                                                                                                                                                                        |       | (3,980                  | )          | (604                   | )          |
| **Total stockholders’ equity**                                                                                                                                                                                                                                                                                                                         |       | 59,933                  |       | 54,878                 |       |
| **Total liabilities and stockholders’ equity**                                                                                                                                                                                                                                                                                                         |       | $                       | 1,222,866  |                   | $          | 1,080,393 |   |

 

The accompanying notes are an integral partof these unaudited consolidated financial statements.

 

2

----

 

**TRINITY CAPITAL CORPORATION &SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF INCOME**

**For the Three and Nine Months Ended September 30,2005 and 2004**

**(Amounts in thousands except share and pershare data)**

**(Unaudited)**

 
| ** **                                               | ** ** | **Three Months Ended**       | ** ** | **Nine Months Ended**        | ** ** |
|----------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                               | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| Interest  income:                                        |       |                         |       |                         |       |   |   |   |   |
| Loans, including fees                                    |       | $                            | 16,505     |                         | $          | 12,760 |   | $ | 46,202 |   | $ | 36,654 |   |
| Investment securities:                                   |       |                         |       |                         |       |   |   |   |   |
| Taxable                                                  |       | 495                          |       | 761                          |       | 1,725 |   | 2,443 |   |
| Nontaxable                                               |       | 199                          |       | 150                          |       | 558 |   | 471 |   |
| Federal funds sold                                       |       | 1                            |       | —                       |       | 9 |   | — |   |
| Other interest bearing deposits                          |       | 332                          |       | 55                           |       | 431 |   | 124 |   |
| Investment in unconsolidated trusts                      |       | 22                           |       | 15                           |       | 53 |   | 42 |   |
| **Total interest income**                                |       | 17,554                       |       | 13,741                       |       | 48,978 |   | 39,734 |   |
| Interest  expense:                                       |       |                         |       |                         |       |   |   |   |   |
| Deposits                                                 |       | 5,633                        |       | 3,178                        |       | 14,375 |   | 9,108 |   |
| Short-term borrowings                                    |       | —                       |       | 51                           |       | 123 |   | 146 |   |
| Long-term borrowings                                     |       | 846                          |       | 572                          |       | 2,249 |   | 1,770 |   |
| Junior subordinated debt owed to  unconsolidated trusts  |       | 714                          |       | 503                          |       | 1,769 |   | 1,414 |   |
| **Total interest expense**                               |       | 7,193                        |       | 4,304                        |       | 18,516 |   | 12,438 |   |
| **Net interest income**                                  |       | 10,361                       |       | 9,437                        |       | 30,462 |   | 27,296 |   |
| Provision for loan losses                                |       | 750                          |       | 450                          |       | 2,100 |   | 1,650 |   |
| **Net interest income after provision for  loan losses** |       | 9,611                        |       | 8,987                        |       | 28,362 |   | 25,646 |   |
| Other income:                                            |       |                         |       |                         |       |   |   |   |   |
| Mortgage loan servicing fees                             |       | 681                          |       | 592                          |       | 1,942 |   | 1,751 |   |
| Loan and other fees                                      |       | 712                          |       | 590                          |       | 2,009 |   | 1,829 |   |
| Service charges on deposits                              |       | 401                          |       | 377                          |       | 1,100 |   | 1,047 |   |
| Gain on sale of loans                                    |       | 665                          |       | 374                          |       | 1,766 |   | 2,373 |   |
| Gain on sale of securities                               |       | —                       |       | —                       |       | — |   | 272 |   |
| Other operating income                                   |       | 414                          |       | 164                          |       | 809 |   | 692 |   |
|                                                     |       | 2,873                        |       | 2,097                        |       | 7,626 |   | 7,964 |   |
| Other  expenses:                                         |       |                         |       |                         |       |   |   |   |   |
| Salaries and employee benefits                           |       | 4,038                        |       | 3,725                        |       | 12,059 |   | 11,433 |   |
| Occupancy                                                |       | 785                          |       | 660                          |       | 2,378 |   | 1,728 |   |
| Data processing                                          |       | 486                          |       | 508                          |       | 1,391 |   | 1,442 |   |
| Marketing                                                |       | 403                          |       | 433                          |       | 1,133 |   | 983 |   |
| Amortization and valuation of mortgage  servicing rights |       | (162                         | )          | 1,230                        |       | 902 |   | 1,120 |   |
| Supplies                                                 |       | 159                          |       | 202                          |       | 559 |   | 583 |   |
| Loss (gain) on sale of other real estate  owned          |       | 123                          |       | (3                           | )          | 950 |   | 125 |   |
| Postage                                                  |       | 142                          |       | 143                          |       | 452 |   | 416 |   |
| Other                                                    |       | 931                          |       | 911                          |       | 3,032 |   | 2,958 |   |
|                                                     |       | 6,905                        |       | 7,809                        |       | 22,856 |   | 20,788 |   |
| **Income before income taxes**                           |       | 5,579                        |       | 3,275                        |       | 13,132 |   | 12,822 |   |
| Income taxes                                             |       | 2,205                        |       | 1,147                        |       | 4,949 |   | 4,885 |   |
| Net income                                               |       | $                            | 3,374      |                         | $          | 2,128 |   | $ | 8,183 |   | $ | 7,937 |   |
| Basic  earnings per common share                         |       | $                            | 0.51       |                         | $          | 0.32 |   | $ | 1.23 |   | $ | 1.18 |   |
| Diluted  earnings per common share                       |       | $                            | 0.50       |                         | $          | 0.31 |   | $ | 1.22 |   | $ | 1.16 |   |

 

The accompanying notes are an integral part of these unauditedconsolidated financial statements.

 

3

----

 

**TRINITY CAPITAL CORPORATION &SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**For the Nine Months Ended September 30,2005 and 2004**

**(Amounts in thousands)**

**(Unaudited)**

 
| ** **                                                                                   | ** ** | **Nine Months Ended**       | ** ** |
|----------------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                   | ** ** | **September 30, 2005** | ** ** | **September 30, 2004** | ** ** |
| ** **                                                                                   | ** ** | ** **                  | ** ** | ** ** | ** ** |
| Cash Flows  From Operating Activities                                                        |       |                        |       |   |   |
| Net income                                                                                   |       | $                           | 8,183      |   | $ | 7,937 |   |
| Adjustments to reconcile net income to net  cash provided by (used in) operating activities: |       |                        |       |   |   |
| Depreciation and amortization                                                                |       | 1,937                       |       | 1,627 |   |
| Net amortization of:                                                                         |       |                        |       |   |   |
| Mortgage servicing rights                                                                    |       | 2,069                       |       | 2,016 |   |
| Premiums and discounts on investment  securities                                             |       | 722                         |       | 1,055 |   |
| Junior subordinated debt owed to  unconsolidated trusts issuance costs                       |       | 15                          |       | 15 |   |
| Provision for loan losses                                                                    |       | 2,100                       |       | 1,650 |   |
| Recovery of mortgage servicing rights                                                        |       | (1,167                      | )          | (896 | ) |
| Loss on disposal of premises and equipment                                                   |       | 143                         |       | — |   |
| Gain on sale of available for sale  securities                                               |       | —                      |       | (272 | ) |
| Federal Home Loan Bank (FHLB) stock  dividends received                                      |       | (146                        | )          | (67 | ) |
| Gain on sale of loans                                                                        |       | (1,766                      | )          | (2,373 | ) |
| Loss on disposal of other real estate owned                                                  |       | 157                         |       | 148 |   |
| Write-down of value of other real estate  owned                                              |       | 793                         |       | 61 |   |
| (Increase) decrease in other assets                                                          |       | (923                        | )          | 1,877 |   |
| Increase (decrease) in other liabilities                                                     |       | 312                         |       | (518 | ) |
| Tax benefit recognized for exercise of  stock options                                        |       | 272                         |       | 53 |   |
| Release of Employee Stock Ownership Plan  (ESOP) shares                                      |       | 913                         |       | 950 |   |
| **Net cash provided by operating activities  before originations and gross sales of loans**  |       | 13,614                      |       | 13,263 |   |
| Gross sales of loans held for sale                                                           |       | 139,032                     |       | 178,432 |   |
| Origination of loans held for sale                                                           |       | (145,750                    | )          | (178,989 | ) |
| **Net cash provided by operating activities**                                                |       | 6,896                       |       | 12,706 |   |
| Cash Flows  From Investing Activities                                                        |       |                        |       |   |   |
| Proceeds from maturities and paydowns of  investment securities, available for sale          |       | 7,075                       |       | 44,760 |   |
| Proceeds from maturities and paydowns of  investment securities, held to maturity            |       | 28,357                      |       | 5,166 |   |
| Proceeds from maturities and paydowns of  investment servurities, other                      |       | 325                         |       | 300 |   |
| Proceeds from sale of investment  securities, available for sale                             |       | —                      |       | 28,388 |   |
| Purchase of investment securities available  for sale                                        |       | (4,090                      | )          | (28,095 | ) |
| Purchase of investment securities other                                                      |       | (707                        | )          | (1,327 | ) |
| Proceeds from sale of other real estate  owned                                               |       | 5,633                       |       | 2,604 |   |
| Loans funded, net of repayments                                                              |       | (112,268                    | )          | (110,028 | ) |
| Purchases of premises and equipment                                                          |       | (1,430                      | )          | (8,281 | ) |
| Proceeds from sale of premises and  equipment                                                |       | 100                         |       | — |   |
| **Net cash used in investing activities**                                                    |       | (77,005                     | )          | (66,513 | ) |
| Cash Flows  From Financing Activities                                                        |       |                        |       |   |   |
| Net increase in demand deposits, NOW  accounts and savings accounts                          |       | 36,464                      |       | 40,815 |   |
| Net increase (decrease) increase in time  deposits                                           |       | 104,508                     |       | (8,327 | ) |
| Proceeds from issuances of borrowings                                                        |       | 30,000                      |       | 481,700 |   |
| Repayment of borrowings                                                                      |       | (40,145                     | )          | (456,017 | ) |
| Repayment of ESOP debt                                                                       |       | (472                        | )          | (471 | ) |
| Proceeds from issuance of trust preferred  securities                                        |       | 10,310                      |       | 6,186 |   |
| Purchase of treasury stock                                                                   |       | (4,422                      | )          | (117 | ) |
| Issuance of common stock for stock option  plan                                              |       | 666                         |       | 72 |   |
| Dividend payments                                                                            |       | (4,057                      | )          | (4,098 | ) |
| **Net cash provided by financing activities**                                                |       | 132,852                     |       | 59,743 |   |
| **Net increase in cash and cash equivalents**                                                |       | 62,743                      |       | 5,936 |   |
| Cash and  cash equivalents:                                                                  |       |                        |       |   |   |
| Beginning of year                                                                            |       | 23,814                      |       | 43,111 |   |
| End of period                                                                                |       | $                           | 86,557     |   | $ | 49,047 |   |
| Supplemental  Disclosures of Cash Flow Information                                           |       |                        |       |   |   |
| Cash payments for:                                                                           |       |                        |       |   |   |
| Interest                                                                                     |       | $                           | 17,916     |   | $ | 12,741 |   |
| Income taxes                                                                                 |       | 5,245                       |       | 2,562 |   |
| Non-cash investing and financing  activities:                                                |       |                        |       |   |   |
| Transfers from loans to other real estate  owned                                             |       | 475                         |       | 2,158 |   |
| Dividends declared, not yet paid                                                             |       | 3                           |       | — |   |
| Change in unrealized gain on investment  securities, net of taxes                            |       | (36                         | )          | (166 | ) |

 

The accompanying notes are an integral partof these unaudited consolidated financial statements.

 

4

----

 

**TRINITY CAPITAL CORPORATION &SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**Note 1. Basis of Presentation**

 

The accompanying unaudited consolidatedfinancial statements include the consolidated balances and results ofoperations of Trinity Capital Corporation (“Trinity” or the “Company”) and itswholly owned subsidiaries: Los Alamos National Bank (the “Bank”) and TitleGuaranty & Insurance Company (“Title Guaranty”), collectively referredto as the “Company.”  Trinity CapitalTrust I (“Trust I”), Trinity Capital Trust II (“Trust II”),Trinity Capital Trust III (“Trust III”), and Trinity Capital Trust IV (“TrustIV”), collectively referred to as the “Trusts”, which are also wholly ownedsubsidiaries of Trinity, are not consolidated in these financialstatements.  The business activities ofthe Company consist solely of the operations of its wholly ownedsubsidiaries.  All significantintercompany balances and transactions have been eliminated inconsolidation.  In the opinion ofmanagement, all adjustments (consisting only of normal recurring adjustments)necessary for a fair presentation of the financial position, results ofoperations and cash flows for the interim periods have been made.  The results of operations for the three and ninemonths ended September 30, 2005 are not necessarily indicative of theresults to be expected for the entire fiscal year.

 

The unaudited interim consolidated financial statements have beenprepared in conformity with accounting principles generally accepted in theUnited States of America and industry practice. Certain information in footnote disclosure normally included infinancial statements prepared in accordance with accounting principlesgenerally accepted in the United States of America and industry practice hasbeen condensed or omitted pursuant to rules and regulations of theSecurities and Exchange Commission. These financial statements should be read in conjunction with theconsolidated financial statements and notes thereto included in the Company’s December 31,2004 audited financial statements filed on Form 10-K.

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions which affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesas of the date of the financial statements, as well as the reported amounts ofincome and expenses during the reported periods.  Actual results could differ from thoseestimates.

 

**Note 2.  Comprehensive Income**

 

Comprehensive income includes net income, as well as the change in netunrealized gain on investment securities available for sale, net of tax.  Comprehensive income was $3.4 million and $2.3million for the three month periods ended September 30, 2005 and 2004,respectively, and $8.1 million and $7.8 million for the nine month periodsended September 30, 2005 and 2004, respectively.

 

**Note 3.  Earnings Per Share Data**

 

The following table sets forth the computation of basic and dilutedearnings per share for the periods indicated:

 
| ** **                                                                         | ** ** | **Three Months Ended**                                         | ** ** | **Nine Months Ended**  | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                         | ** ** | **September 30,**                                         | ** ** | **September 30,** | ** ** |
| ** **                                                                         | ** ** | **2005**                                                       | ** ** | **2004**               | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                         | ** ** | **(Unaudited; in thousands, except share and per share data)** | ** ** |
| Net income                                                                         |       | $                                                              | 3,374      |                   | $          | 2,128 |   | $ | 8,183 |   | $ | 7,937 |   |
| Weighted  average common shares issued                                             |       | 6,856,800                                                      |       | 6,856,800              |       | 6,856,800 |   | 6,856,800 |   |
| LESS:  Weighted average treasury stock shares                                      |       | (153,075                                                       | )          | (25,734                | )          | (142,414 | ) | (27,951 | ) |
| LESS: Weighted average unearned Employee  Stock Ownership Plan (ESOP) stock shares |       | (73,348                                                        | )          | (99,748                | )          | (75,085 | ) | (101,582 | ) |
| Weighted  average common shares outstanding, net                                   |       | 6,630,377                                                      |       | 6,731,318              |       | 6,639,301 |   | 6,727,267 |   |
| Basic  earnings per common share                                                   |       | $                                                              | 0.51       |                   | $          | 0.32 |   | $ | 1.23 |   | $ | 1.18 |   |
| Weighted  average dilutive shares from stock option plan                           |       | 59,354                                                         |       | 108,718                |       | 65,228 |   | 111,035 |   |
| Weighted average common shares outstanding  including dilutive shares              |       | 6,689,731                                                      |       | 6,840,036              |       | 6,704,529 |   | 6,838,302 |   |
| Diluted  earnings per common share                                                 |       | $                                                              | 0.50       |                   | $          | 0.31 |   | $ | 1.22 |   | $ | 1.16 |   |

 

5

----

 

**Note 4.  Recent AccountingPronouncements and Regulatory Developments**

 

In December 2004,the FASB issued SFAS No. 123R,*Share-Based Payment*,which is an Amendment of FASB Statement Nos. 123 and 95.  SFAS No. 123R changes, among otherthings, the manner in which share-based compensation, such as stock options,will be accounted for by both public and non-public companies.  For public companies, the cost of employeeservices received in exchange for equity instruments including options andrestricted stock awards generally will be measured at fair value at the grantdate.  The grant date fair value will beestimated using option-pricing models adjusted for the unique characteristicsof those options and instruments, unless observable market prices for the sameor similar options are available.  Thecost will be recognized over the requisite service period, often the vestingperiod.

 

Thechanges in accounting will replace existing requirements under SFAS No. 123,*Accounting for Stock-Based Compensation*,and will eliminate the ability to account for share-based compensationtransactions using APB Opinion No. 25, *Accounting for StockIssued to Employees*, which does not require companies to expenseoptions if the exercise price is equal to the trading price at the date of grant.  The accounting for similar transactionsinvolving parties other than employees or the accounting for employee stockownership plans that are subject to AICPA Statement of Position 93-6, *Employers’ Accounting for Employee Stock Ownership Plans*,would remain unchanged.  See Note 9 belowfor the Company’s current application of SFAS No. 123.

 

OnApril 14, 2005, the Securities and Exchange Commission (SEC) announced theadoption of a new rule that amends the compliance dates for SFAS No. 123R.  Under SFAS No. 123R, the Company wouldhave been required to implement the standard as of the beginning of the firstinterim period that begins after June 15, 2005.  The SEC’s new rule allows companies toimplement SFAS No. 123R at the beginning of their next fiscal year(beginning January 1, 2006, in the case of the Company), instead of thenext reporting period that begins after June 15, 2005.  The SEC’s new rule does not change theaccounting required by SFAS No. 123R; it changes only the dates forcompliance with the standard.

 

InMay 2005, the FASB issued SFAS No. 154, *AccountingChanges and Error Corrections*, which provides guidance on theaccounting for and reporting of accounting changes and error corrections.  It establishes, unless impracticable,retrospective application as the required method for reporting a change inaccounting principle in the absence of explicit transition requirementsspecific to the newly adopted accounting principle.  The reporting of a correction of an error byrestating previously issued financial statements is also addressed by thisstatement.  SFAS No. 154 iseffective for accounting changes and corrections of errors made in fiscal yearsbeginning after December 15, 2005.

 

**Note5.  Short Term Borrowings**

 

The Companyhad no Federal Home Loan Bank advances with maturities of less than one year asof September 30, 2005.  As of December 31,2004, the Company had Federal Home Loan Bank advances with maturities of lessthan one year of $34.4 million.

 

**Note 6.  Long Term Borrowings**

 

The Company had Federal Home Loan Bank advances withmaturity dates greater than one year of $84.3 million and $60.0 million as of September 30,2005 and December 31, 2004, respectively. As of September 30, 2005, the advances had fixed interest ratesranging from 3.22% to 6.34%.

 

6

----

 

**Note 7. Junior Subordinated Debt Owed to Unconsolidated Trusts**

 

The following table presents details on the junior subordinated debt owed to unconsolidated trusts as of September 30, 2005:

 
| ** **                                                  | ** ** | **Trust I**                | ** ** | **Trust II**           | ** ** | **Trust III**          | ** ** | **Trust IV**           | ** ** |
|-------------------------------------------------------------|------------|----------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                  | ** ** | **(Dollars in thousands)** | ** ** |
| Date of  issue                                              |       | March 23, 2000        |       | November 28, 2001 |       | May 11, 2004      |       | June 29, 2005     |       |
| Amount of  trust preferred securities issued                |       | $                          | 10,000     |                   | $          | 6,000                  |       | $                      | 6,000      |   | $ | 10,000 |   |
| Rate on  trust preferred securities                         |       | 10.875                     | %          | 9.95                   | %          | 6.57% (variable        | )          | 6.88                   | %          |
| Maturity                                                    |       | March 8, 2030         |       | December 8, 2031  |       | September 8, 2034 |       | November 23, 2035 |       |
| Date of  first redemption                                   |       | March 8, 2010         |       | December 8, 2006  |       | September 8, 2009 |       | August 23, 2010   |       |
| Common  equity securities issued                            |       | $                          | 310        |                   | $          | 186                    |       | $                      | 186        |   | $ | 310 |   |
| Junior subordinated deferrable interest  debentures owed    |       | $                          | 10,310     |                   | $          | 6,186                  |       | $                      | 6,186      |   | $ | 10,310 |   |
| Rate on junior subordinated deferrable  interest debentures |       | 10.875                     | %          | 9.95                   | %          | 6.57% (variable        | )          | 6.88                   | %          |

 

On the dates of issue indicated above, the Trusts, being Delaware statutory business trusts, issued trust preferred securities (the “trust preferred securities”) in the amount and at the rate indicated above.  These securities represent preferred beneficial interests in the assets of the Trusts.  The trust preferred securities will mature on the dates indicated, and are redeemable in whole or in part at the option of the Company at any time after the date of first redemption indicated above, with the approval of the Federal Reserve Board and in whole at any time upon the occurrence of certain events affecting their tax or regulatory capital treatment.  The Trusts also issued common equity securities to Trinity in the amounts indicated above.  The Trusts used the proceeds of the offering of the trust preferred securities to purchase junior subordinated deferrable interest debentures (the “debentures”) issued by the Company, which have terms substantially similar to the trust preferred securities.  The Company has the right to defer payments of interest on the debentures at any time or from time to time for a period of up to ten consecutive semi-annual periods with respect to each interest payment deferred.  Under the terms of the debentures, under certain circumstances of default or the Company has elected to defer interest on the debentures, the Company may not, with certain exceptions, declare or pay any dividends or distributions on its capital stock or purchase or acquire any of its capital stock.  The Company used the majority of the proceeds from the sale of the debentures to add to Tier 1 or Tier 2 capital in order to support its growth and to purchase treasury stock.

 

Trinity owns all of the outstanding common securities of the Trusts.  The Trusts are considered variable interest entities (VIEs) under *Financial Accounting Standards Board Interpretation (FIN) No. 46, “Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51”*, as revised.  Prior to FIN 46, VIEs were generally consolidated by an enterprise when the enterprise had a controlling financial interest through ownership of a majority of voting interest in the entity.  Under FIN 46, a VIE should be consolidated by its primary beneficiary.  The Company implemented FIN 46 during the fourth quarter of 2003.  Because Trinity is not the primary beneficiary of the Trusts, the financial statements of the Trusts are no longer included in the consolidated financial statements of the Company.  The Company’s prior financial statements have been reclassified to de-consolidate the Company’s investment in the Trusts.

 

In March 2005, the Board of Governors of theFederal Reserve System issued a final rule allowing bank holding companiesto continue to include qualifying trust preferred securities in their Tier 1Capital for regulatory capital purposes, subject to a 25% limitation to allcore (Tier I) capital elements, net of goodwill less any associated deferredtax liability.  The final rule providesa five-year transition period, ending March 31, 2009, for application ofthe aforementioned quantitative limitation. As of September 30, 2005, 79% of the trust preferred securitiesnoted in the table above qualified as Tier I capital and 21% qualified as Tier2 capital under the final rule adopted in March 2005.

 

Payments of distributions on the trust preferred securities and payments on redemption of the trust preferred securities are guaranteed by the Company on a limited basis.  The Company also entered into an agreement as to expenses and liabilities with the Trusts pursuant to which it agreed, on a subordinated basis, to pay any costs, expenses or liabilities of the Trusts other than those arising under the trust preferred securities.  The obligations of the Company under the junior subordinated debentures, the related indenture, the trust agreement establishing the Trusts, the guarantee and the agreement as to expenses and liabilities, in the aggregate, constitute a full and unconditional guarantee by the Company of the Trusts’ obligations under the trust preferred securities.

 

Issuance costs of $615 thousand related to the first three trustpreferred securities issues were deferred and are being amortized over theperiod until mandatory redemption of the securities in March 2030, December 2031and September 2034, respectively. During each of the three month periods ended September 30, 2005 and2004, $5 thousand of these issuance costs were amortized.  During each of

 

7

----

 

the nine month periods ended September 30,2005 and 2004, $15 thousand of these issuance costs were amortized.  Unamortized issuance costs were $524 thousandand $539 thousand at September 30, 2005 and December 31, 2004,respectively.  There were no issuancecosts associated with the fourth trust preferred security issue.

 

Dividends accrued and unpaid to securities holders totaled $364 thousandand $282 thousand on September 30, 2005 and 2004, respectively.

 

8

----

 

**Note 8. Commitments, Contingencies and Off-Balance Sheet Activities**

 

*Credit-related financial instruments:*  The Company is a party to credit-related commitmentswith off-balance-sheet risk in the normal course of business to meet thefinancing needs of its customers.  These credit-relatedcommitments include commitments to extend credit, standby letters of credit andcommercial letters of credit.  Such credit-relatedcommitments involve, to varying degrees, elements of credit and interest raterisk in excess of the amount recognized in the consolidated balance sheets.

 

The Company’s exposure to credit loss is represented by the contractualamount of these credit-related commitments. The Company follows the same credit policies in making credit-related commitmentsas it does for on-balance-sheet instruments.

 

At September 30, 2005 and December 31, 2004, the following credit-relatedcommitments were outstanding whose contract amounts represent credit risk:

 
| ** **                                  | ** ** | **Contract Amount**     | ** ** |
|---------------------------------------------|------------|-------------------------|------------|
| ** **                                  | ** ** | **September  30, 2005** | ** ** | **December  31, 2004** | ** ** |
| ** **                                  | ** ** | **(In thousands)**      | ** ** |
| Unfunded  commitments under lines of credit |       | $                       | 175,974    |   | $ | 168,794 |   |
| Commercial  and standby letters of credit   |       | 37,059                  |       | 33,319 |   |
|                                             |            |                         |            |  |  |  |  |

 

Commitments to extend credit are agreementsto lend to a customer as long as there is no violation of any conditionestablished in the contract.  Commitmentsgenerally have fixed expiration dates or other termination clauses and mayrequire a payment of a fee.  Thecommitments for equity lines of credit may expire without being drawnupon.  Therefore, the total commitmentamounts do not necessarily represent future cash requirements.  The amount of collateral obtained, if it isdeemed necessary by the Company, is based on management’s credit evaluation ofthe customer.  Unfunded commitments undercommercial lines of credit, revolving credit lines and overdraft protectionagreements are commitments for possible future extensions of credit to existingcustomers.  Overdraft protectionagreements are uncollateralized, but most other unfunded commitments havecollateral.  These unfunded lines ofcredit usually do not contain a specified maturity date and may not necessarilybe drawn upon to the total extent to which the Company is committed.

 

Commercial and standby letters of credit are conditional credit-relatedcommitments issued by the Company to guarantee the performance of a customer toa third party.  Those letters of creditare primarily issued to support public and private borrowing arrangements.  Essentially all letters of credit issued haveexpiration dates within one year. The credit risk involved in issuing letters ofcredit is the same as that involved in extending loans to customers.  The Company generally holds collateralsupporting those credit-related commitments. In the event the customer does notperform in accordance with the terms of the agreement with the third party, theCompany would be required to fund the credit-related commitment.  The maximum potential amount of futurepayments the Company could be required to make is represented by thecontractual amount shown in the summary above. If the credit-related commitment is funded, the Company would beentitled to seek recovery from the customer. At September 30, 2005 and December 31, 2004, no amounts havebeen recorded as liabilities for the Company’s potential obligations underthese credit-related commitments.  Thefair value of these credit-related commitments is approximately equal to thefees collected when granting these letters of credit.  These fees collected were $97 thousand and $60thousand as of September 30, 2005 and December 31, 2004, respectively,and are included in “other liabilities” on the Company’s balance sheets.

 

*Concentrations of credit risk:*  The majority of the loans, commitments toextend credit, and standby letters of credit have been granted to customers inLos Alamos and surrounding communities. Although the Company has a diversified loan portfolio, a substantialportion of its loans are made to businesses and individuals associated with, oremployed by, Los Alamos National Laboratory (“the Laboratory”).  The ability of such borrowers to honor theircontracts is predominately dependent upon the continued operation and fundingof the Laboratory.  Investments insecurities issued by states and political subdivisions involve governmentalentities within the State of New Mexico. The distribution of types of commitments to extend credit approximatesthe distribution of loans outstanding. Standby letters of credit were granted primarily to commercial borrowers.

 

*Contingencies:*  In the normal course of business, the Companyis involved in various legal proceedings. In the opinion of management, after consulting with counsel, probable liabilitiesresulting from such proceedings would not have a material adverse effect on theCompany’s consolidated financial statements.

 

9

----

 

**Note 9.  Pro Forma Impact ofStock-Based Compensation Plans**

 

As allowed under SFAS No. 123, *Accountingfor Stock-Based Compensation*, the Company measures stock-basedcompensation cost in accordance with the methods prescribed in AccountingPrinciples Board (APB) Opinion No. 25, *Accountingfor Stock Issued to Employees*.  As stock options are granted atfair value, there are no charges to earnings associated with stock optionsgranted.  Accordingly, no compensation cost has been recognized for grantsmade to date.  Had compensation cost been determined based on the fairvalue method prescribed in FASB Statement No. 123, reported net income andearnings per common share would have been reduced to the pro forma amountsshown below (dollars in thousands, except earnings per share data): 
| ** **                                                                                                                                    | ** ** | **Three Months Ended  September 30,**          | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                                                    | ** ** | **2005**                                            | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                                                                    | ** ** | **(Unaudited; in thousands except per share data)** | ** ** |
| Net income  as reported                                                                                                                       |       | $                                                   | 3,374      |                                      | $          | 2,128 |   | $ | 8,183 |   | $ | 7,937 |   |
| Deduct: Total stock-based employee  compensation expense determined under fair value based method for all awards,  net of related tax effects |       | 57                                                  |       | 28                                        |       | 114 |   | 85 |   |
|                                                                                                                                          |       |                                                |       |                                      |       |   |   |   |   |
| Pro forma  net income                                                                                                                         |       | $                                                   | 3,317      |                                      | $          | 2,100 |   | $ | 8,069 |   | 7,852 |   |
|                                                                                                                                          |       |                                                |       |                                      |       |   |   |   |   |
| Earnings per  share:                                                                                                                          |       |                                                |       |                                      |       |   |   |   |   |
| Basic – as  reported                                                                                                                     |       | $                                                   | 0.51       |                                      | $          | 0.32 |   | $ | 1.23 |   | $ | 1.18 |   |
| Basic – pro  forma                                                                                                                       |       | $                                                   | 0.50       |                                      | $          | 0.31 |   | $ | 1.22 |   | $ | 1.17 |   |
|                                                                                                                                          |       |                                                |       |                                      |       |   |   |   |   |
| Diluted – as  reported                                                                                                                   |       | $                                                   | 0.50       |                                      | $          | 0.31 |   | $ | 1.22 |   | $ | 1.16 |   |
| Diluted –  pro forma                                                                                                                     |       | $                                                   | 0.50       |                                      | $          | 0.31 |   | $ | 1.20 |   | $ | 1.15 |   |

 

10

----

 

**Item 2.  Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

*This discussion is intended to focus oncertain financial information regarding the Company and the Bank and is writtento provide the reader with a more thorough understanding of its financialstatements. The following discussion and analysis of the Company’s financialposition and results of operations should be read in conjunction with theinformation set forth in Item 3, Quantitative and Qualitative Disclosuresabout Market Risk and the annual audited consolidated financial statements filedon Form 10-K.*

 

**Special Note Concerning Forward-LookingStatements**

 

This Form 10-Q contains, and future oral and written statements ofthe Company may contain, forward-looking statements, within the meaning of suchterm in the Private Securities Litigation Reform Act of 1995, with respect tothe financial condition, results of operations, plans, objectives, futureperformance and business of the Company. Forward-looking statements, which maybe based upon beliefs, expectations and assumptions of our management and oninformation currently available to management, are generally identifiable bythe use of words such as “believe,” “expect,” “anticipate,” “plan,” “intend,” “estimate,”“may,” “will,” “would,” “could,” “should” or other similar expressions. Additionally,all statements in this document, including forward-looking statements, speakonly as of the date they are made, and we undertake no obligation to update anystatement in light of new information or future events.

 

Our ability to predict results or the actual effect of future plans orstrategies is inherently uncertain. Factors which could have a material adverseeffect on our operations and future prospects include, but are not limited to,the following:

 

•                                          Thestrength of the United States economy in general and the strength of the localeconomies in which we conduct our operations which may be less favorable thanexpected and may result in, among other things, a deterioration in the creditquality and value of our assets.

 

•                                          Theeconomic impact of any future terrorist threats or attacks, and the response ofthe United States to any such threats and attacks.

 

•                                          Theeffects of, and changes in, federal, state and local laws, regulations andpolicies affecting banking, securities, insurance and monetary and financialmatters.

 

•                                          Theeffects of changes in interest rates (including the effects of changes in therate of prepayments of the Company’s assets) and the policies of the Board ofGovernors of the Federal Reserve System.

 

•                                          Ourability to compete with other financial institutions as effectively as wecurrently intend due to increases in competitive pressures in the financialservices sector.

 

•                                          Ourability to obtain new customers and to retain existing customers.

 

•                                          Thetimely development and acceptance in the market of products and services,including products and services offered through alternative delivery channelssuch as the Internet.

 

•                                          Technologicalchanges implemented by us and by other parties, including third party vendors,which may be more difficult or more expensive than anticipated or which mayhave unforeseen consequences to us and our customers.

 

•                                          Ourability to develop and maintain secure and reliable electronic systems.

 

•                                          Ourability to retain key executives and employees and the difficulty that we mayexperience in replacing key executives and employees in an effective manner.

 

•                                          Consumerspending and saving habits which may change in a manner that affects ourbusiness adversely.

 

•                                          Businesscombinations and the integration of acquired businesses which may be moredifficult or expensive than expected.

 

•                                          Thecosts, effects and outcomes of existing or future litigation.

 

11

----

 

•                                          Changesin accounting policies and practices, as may be adopted by state and federalregulatory agencies and the Financial Accounting Standards Board.

 

•                                          Ourability to manage the risks associated with the foregoing as well asanticipated.

 

•                                          Changesin the management and national policy regarding Los Alamos National Laboratory(the “Laboratory”), including changes in the level of funding.

 

These risks and uncertainties should beconsidered in evaluating forward-looking statements and undue reliance shouldnot be placed on such statements. Additional information concerning the Companyand our business, including other factors that could materially affect ourfinancial results, will be included in our filings with the Securities andExchange Commission.

 

**Critical Accounting Policies**

 

***Allowance for LoanLosses:*** Management believes the allowance for loan losses accounting policy iscritical to the portrayal and understanding of our financial condition andresults of operations.  As such,selection and application of this “critical accounting policy” involvesjudgments, estimates, and uncertainties that are susceptible to change.  In the event that different assumptions orconditions were to prevail, and depending upon the severity of such changes,the possibility of materially different financial condition or results ofoperations is a reasonable likelihood.

 

The allowance for loan losses is maintainedat an amount that management believes will be adequate to absorb probablelosses on existing loans, based on an evaluation of the collectibility of loansand prior loss experience.  Thisevaluation also takes into consideration such factors as changes in the natureand volume of the loan portfolio, the value of underlying collateral, overallportfolio quality, review of specific problem loans and current economicconditions that may affect the borrower’s ability to pay.  While management uses the best informationavailable to make its evaluation, future adjustments to the allowance may benecessary if there are significant changes in these factors.  In addition, as an integral part of theirexamination process regulatory agencies periodically review our allowance forloan losses and may require us to make changes to the allowance based on theirevaluation of information available at the time of their examinations.

 

We maintain our allowance for loan losses at a level that managementbelieves will be adequate to absorb probable losses on existing loans based onan evaluation of the collectibility of loans and prior loss experience.  Three methods are used to evaluate the adequacyof the allowance for loan losses: (1) historical loss experience, based onloss experience by quality classification in the previous twelve calendarquarters; (2) specific identification, based upon management’s assessmentof loans and the probability that a charge off will occur in the upcomingquarter; and (3) loan concentrations, based on current or expectedeconomic factors in the geographic and industry sectors where managementbelieves we may eventually experience some loan losses.  While we believe that our allowance for loanlosses was adequate to absorb estimated loan losses as of September 30,2005, there can be no assurance that future losses will not exceed theestimated amounts or that we will not be required to make additional provisionsfor losses in the future.

 

***Mortgage Servicing Right (MSR) Assets:***  Servicing residential mortgage loans for third-party investors represents a significant business activity of the Bank.  As of September 30, 2005, mortgage loans serviced for others totaled $932.7 million.  The MSRs on these loans totaled $8.9 million as of September 30, 2005.  The expected and actual rates of mortgage loan prepayments are the most significant factors driving the value of MSRs.  Increases in mortgage loan prepayments reduce estimated future net servicing cash flows because the life of the underlying loan is reduced.  In determining the initial value of the MSRs, mortgage interest rates, which are used to determine prepayment rates and discount rates, are held constant over the estimated life of the portfolio.  Fair values of the MSRs are provided by an independent third-party broker of MSRs on a monthly basis.  The values given by the broker are based upon current market conditions and assumptions, which incorporate the expected life of the loans, estimated costs to service the loans, servicing fees to be received and other factors.  MSRs are carried at the lower of the initial capitalized amount, net of accumulated amortization, or fair value.

 

The fair value of the MSRs is driven primarily by the effect current mortgage interest rates have on the likelihood borrowers will prepay the underlying mortgages by refinancing at a lower rate.  Accordingly, higher interest rates decrease the likelihood of repayment, extending the life of the MSRs and increasing the value of these assets.  Lower interest rates increase the likelihood of repayment, contracting the life of the MSRs and decreasing the value of these assets.  This can have a significant impact on our income.  There is no certainty on the direction and amount of interest rate changes looking forward, and therefore, there is no certainty on the amount or direction of the change in valuation.

 

12

----

 

An analysis of changes in mortgage servicing rights follows:

 
| ** **                                                    | ** ** | **Three months ended** | ** ** | **Nine months ended**  | ** ** |
|---------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                    | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                    | ** ** | **2005**               | ** ** | **2004**               | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                    | ** ** | **(In thousands)**     | ** ** |
| Balance,  beginning of period                                 |       | $                      | 8,162      |                   | $          | 9,278 |   | $ | 8,371 |   | $ | 7,792 |   |
| Servicing  rights originated and capitalized                  |       | 597                    |       | 397                    |       | 1,452 |   | 1,774 |   |
| Amortization                                                  |       | (689                   | )          | (708                   | )          | (2,069 | ) | (2,016 | ) |
| Valuation  allowance due to changes in prepayment assumptions |       | 851                    |       | (521                   | )          | 1,167 |   | 896 |   |
|                                                          |       | $                      | 8,921      |                   | $          | 8,446 |   | $ | 8,921 |   | $ | 8,446 |   |

 

**Overview**

 

The Company’s net income substantiallyincreased from the second quarter of 2005 to the third quarter of 2005.  Net income increased $933 thousand (38.2%) inthe third quarter of 2005.  The Company’snet income also increased $1.2 million (58.6%) from the third quarter of 2004to the third quarter of 2005.  This increasewas mainly due to a decrease in the valuation allowance of mortgage servicingrights due to an increase in interest rates between 2004 and 2005.  The Company’s balance sheet growth continuedto be strong, with total assets growing $142.5 million (13.2%) from December 31,2004 to September 30, 2005.

 

Net income for the nine months ended September 30,2005  increased by $246 thousand (3.1%)over the same period in 2004.  Thisincrease was primarily due to an increase in net interest income due to stronggrowth in earning assets, which was partially offset by increases in theprovision for loan loss expense and other expenses.

 

**Income Statement Analysis**

 

***Net Income-General.***  Net income for the three months ended September 30,2005 was $3.4 million, compared to $2.1 million for the same period of 2004.  Diluted earnings per share increased by $0.19to $0.50 for the three months ended September 30, 2005 from $0.31 for thesame period of 2004.  This represented anincrease in diluted earnings per share of 61.3%.  The increase in net income was primarily theresult of a decrease in the valuationallowance of mortgage servicing rights of $1.4 million due to an increase ininterest rates between the two periods. Net interest income (not on a fully tax equivalent basis) also increased$924 thousand between the two periods, mainly due to an increase in averageearning assets.   The gain on sale of loans increased $291thousand, due to an increase in the sale of loans between the two periods.  Title insurance premiums increased $241thousand mainly due to additional business generated from Title Guaranty’s newSanta Fe office.  These items were partiallyoffset by an increase in salaries and employee benefits expense of $313thousand and an increase in the provision for loan losses expense of $300thousand.  The effect of these items, netof taxes, was an increase of $1.2 million in net income for the three monthsended September 30, 2005 compared to the same period in 2004.

 

Net income for the nine months ended September 30, 2005 was $8.2million, compared to $7.9 million for the same period of 2004.  Diluted earnings per share increased by $0.06to $1.22 for the nine months ended September 30, 2005 from $1.16 for thesame period of 2004.  This represented anincrease in diluted earnings per share of 5.2%.  The increase in net income was primarily theresult of an increase in net interestincome (not on a fully tax equivalent basis) of $3.2 million mainly due to anincrease in average earning assets.  This item was partially offset by an increasein the loss on sale of other real estate owned of $825 thousand, an increase inoccupancy expense of $650 thousand, a decrease in the gain on sale of loans of$607 thousand, an increase in the provision for loan loss expense of $450thousand and a decrease in the gain on sale of securities of $272 thousand.  The increase in the loss on sale of otherreal estate owned was mainly due to the disposal of several residential realestate properties acquired in foreclosure. The gain on sale of loans decreased due to fewer loans being sold in thefirst nine months of 2005 compared to the same period in 2004.  The increase in occupancy expense was mainlydue to the Santa Fe Downtown office being opened for nine months in 2005compared to just one month in 2004.  Theprovision for loan losses increased due to an additional large relationshipbeing placed on non-accrual status.  Thegain on sale of securities decreased to zero due to no sales of securities in2005.  The effect of these items, net oftaxes, was an increase in net income of $246 thousand for the first nine monthsof 2005 compared to the same period in 2004.

 

The profitability of the Company’s operations depends primarily on itsnet interest income, which is the difference between total interest earned oninterest earning assets and total interest paid on interest bearingliabilities. The Company’s net income is affected by its provision for loanlosses as well as other income and other expenses. The provision for loanlosses reflects the amount thought to be adequate to cover probable creditlosses in the loan portfolio. Non-interest income or other income consists ofmortgage loan servicing fees, loan and other fees, service charges on deposits,gain on sale of loans, gain on sale of securities and other operating income.Other expenses include salaries and employee benefits, occupancy expenses, dataprocessing expenses, marketing, amortization and valuation of mortgageservicing rights, supplies expense and other expenses.

 

13

----

 

The amount of net interest income is affected by changes in the volumeand mix of interest earning assets, the level of interest rates earned on thoseassets, the volume and mix of interest bearing liabilities, and the level ofinterest rates paid on those interest bearing liabilities. The provision forloan losses is dependent on changes in the loan portfolio and management’sassessment of the collectibility of the loan portfolio, as well as economic andmarket conditions. Other income and other expenses are impacted by growth ofoperations and growth in the number of accounts through core banking businessgrowth.  Growth in operations affectsother expenses as a result of additional employees, branch facilities andpromotional marketing expense. Growth in the number of accounts affects otherincome including service fees as well as other expenses such as computerservices, supplies,  loss (gain) on saleof other real estate owned, postage, telecommunications and other miscellaneousexpenses.

 

14

----

 

***Net Interest Income.***  The following tables present, for the periodsindicated, the total dollar amount of interest income from average interestearning assets and the resultant yields, as well as the interest expense onaverage interest bearing liabilities, and the resultant costs, expressed bothin dollars and rates:

 
| ** **                                                           | ** ** | **Three Months Ended September 30,** | ** ** |
|----------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                           | ** ** | **2005**                                  | ** ** | **2004** | ** ** |
| ** **                                                           | ** ** | **Average  Balance**                      | ** ** | **Interest** | ** ** | **Yield/Rate** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Yield/Rate** | ** ** |
| ** **                                                           | ** ** | **(Dollars in thousands)**                | ** ** |
| **Interest Earning Assets:**                                         |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Loans(1)(2)                                                          |       | $                                         | 1,006,309  |   | $ | 16,505 |   | 6.51 | % | $ | 819,202 |   | $ | 12,760 |   | 6.20 | % |
| Taxable investment  securities                                       |       | 67,565                                    |       | 495 |   | 2.91 |   | 105,049 |   | 761 |   | 2.88 |   |
| Investment securities  exempt from federal income  taxes(3)          |       | 20,482                                    |       | 320 |   | 6.20 |   | 19,936 |   | 227 |   | 4.53 |   |
| Federal funds sold and  securities purchased under resell agreements |       | 1,132                                     |       | 1 |   | 0.35 |   | 40 |   | — |   | 1.11 |   |
| Other interest bearing  deposits                                     |       | 36,946                                    |       | 332 |   | 3.57 |   | 16,115 |   | 55 |   | 1.36 |   |
| Investment in  unconsolidated trust subsidiaries                     |       | 992                                       |       | 22 |   | 8.80 |   | 682 |   | 15 |   | 8.75 |   |
| Total interest earning  assets                                       |       | 1,133,426                                 |       | 17,675 |   | 6.19 |   | 961,024 |   | 13,818 |   | 5.72 |   |
| Non-interest earning  assets                                         |       | 60,897                                    |       |   |   |   |   | 69,926 |   |   |   |   |   |
| Total assets                                                         |       | $                                         | 1,194,323  |   |   |   |   |   | $ | 1,030,950 |   |   |   |   |   |
| **Interest  Bearing Liabilities:**                                   |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                                            |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| NOW and money market  deposit                                        |       | $                                         | 81,140     |   | $ | 307 |   | 1.50 | % | $ | 114,304 |   | $ | 312 |   | 1.09 | % |
| Savings deposit                                                      |       | 366,670                                   |       | 1,540 |   | 1.67 |   | 348,514 |   | 923 |   | 1.05 |   |
| Time deposits                                                        |       | 432,890                                   |       | 3,786 |   | 3.47 |   | 324,895 |   | 1,943 |   | 2.38 |   |
| Short-term borrowings                                                |       | —                                    |       | — |   | — |   | 10,153 |   | 51 |   | 2.00 |   |
| Long-term borrowings                                                 |       | 86,164                                    |       | 846 |   | 3.90 |   | 62,604 |   | 572 |   | 3.63 |   |
| Junior subordinated debt  owed to unconsolidated trusts              |       | 32,992                                    |       | 714 |   | 8.59 |   | 22,682 |   | 503 |   | 8.82 |   |
| Total interest bearing  liabilities                                  |       | 999,856                                   |       | 7,193 |   | 2.85 |   | 883,152 |   | 4,304 |   | 1.94 |   |
| Demand deposits—non-interest  bearing                           |       | 32,390                                    |       |   |   |   |   | 51,771 |   |   |   |   |   |
| Other non-interest  bearing liabilities                              |       | 87,044                                    |       |   |   |   |   | 23,808 |   |   |   |   |   |
| Stockholders’ equity,  including stock owned by ESOP            |       | 75,033                                    |       |   |   |   |   | 72,219 |   |   |   |   |   |
| Total liabilities and  stockholders equity                           |       | $                                         | 1,194,323  |   |   |   |   |   | $ | 1,030,950 |   |   |   |   |   |
|                                                                 |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  income/interest rate Spread(4)                         |       |                                      |       | $ | 10,482 |   | 3.34 | % |   |   | $ | 9,514 |   | 3.78 | % |
|                                                                 |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Net interest margin on a  fully tax equivalent basis(5)              |       |                                      |       |   |   | 3.67 | % |   |   |   |   | 3.94 | % |
| Net interest margin(5)                                               |       |                                      |       |   |   | 3.63 | % |   |   |   |   | 3.91 | % |

 

----

(1)                                  Includesnon-accrual loans of $10.9 million and $3.4 million for the three months ended September 30,2005 and 2004, respectively.

 

(2)                                  Interest incomeincludes loan origination fees of $888 thousand and $896 thousand for the threemonths ended September 30, 2005 and 2004, respectively.

 

(3)                                  Non-taxableinvestment income is presented on a fully tax equivalent basis, adjusting for federaland state exemption of interest income and certain other permanent income taxdifferences.

 

(4)                                  Interest rate spreadrepresents the difference between the average yield on interest earning assetsand the average cost of interest bearing liabilities and is presented on afully tax equivalent basis.

 

(5)                                  Net interest marginrepresents net interest income as a percentage of average interest earningassets.

 

15

----

 

For the third quarter of 2005, net interestincome on a fully tax equivalent basis increased $968 thousand (10.2%) to $10.5million from $9.5 million for the third quarter of 2004.  The increase in net interest income resultedfrom an increase in interest income on a fully tax equivalent basis of $3.9million (27.9%), which was partially offset by an increase in interest expenseof $2.9 million (67.1%).  Interest incomeincreased mainly due to an increase in average earning assets of $172.4 million(17.9%), which accounted for a increase in interest income on a fully taxequivalent basis of $2.9 million.  Therewas also an increase in rate on earning assets of 47 basis points, whichaccounted for an increase of $954 thousand in interest income on a fully taxequivalent basis.  Interest expense increasedmainly due to an increase in the cost of interest-bearing liabilities of 91basis points, which accounted for $1.8 million of the increase.  In addition, total interest-bearingliabilities increased $116.7 million (13.2%), accounting for $1.1 million ofthe increase in interest expense.  Thenet interest margin expressed on a fully tax equivalent basis decreased 27basis points to 3.67% for 2005 from 3.94% for 2004.

 
| ** **                                                 | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                 | ** ** | **2005**                                 | ** ** | **2004** | ** ** |
| ** **                                                 | ** ** | **Average  Balance**                     | ** ** | **Interest** | ** ** | **Yield/Rate** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Yield/Rate** | ** ** |
| ** **                                                 | ** ** | **(Dollars in thousands )**              | ** ** |
| **Interest  Earning Assets:**                              |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Loans(1)(2)                                                |       | $                                        | 966,584    |   | $ | 46,202 |   | 6.39 | % | $ | 790,113 |   | $ | 36,654 |   | 6.20 | % |
| Taxable investment  securities                             |       | 78,375                                   |       | 1,725 |   | 2.94 |   | 114,422 |   | 2,443 |   | 2.85 |   |
| Investment securities  exempt from federal income taxes(3) |       | 18,342                                   |       | 866 |   | 6.31 |   | 20,586 |   | 734 |   | 4.76 |   |
| Federal funds sold                                         |       | 998                                      |       | 9 |   | 1.21 |   | 40 |   | — |   | 0.89 |   |
| Other interest bearing  deposits                           |       | 17,236                                   |       | 431 |   | 3.34 |   | 15,217 |   | 124 |   | 1.09 |   |
| Investment in  unconsolidated trust subsidiaries           |       | 789                                      |       | 53 |   | 8.98 |   | 593 |   | 42 |   | 9.46 |   |
| Total interest earning  assets                             |       | 1,082,324                                |       | 49,286 |   | 6.09 |   | 940,971 |   | 39,997 |   | 5.68 |   |
| Non-interest earning  assets                               |       | 64,775                                   |       |   |   |   |   | 72,601 |   |   |   |   |   |
| Total assets                                               |       | $                                        | 1,147,099  |   |   |   |   |   | $ | 1,013,572 |   |   |   |   |   |
| **Interest  Bearing Liabilities:**                         |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                                  |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| NOW and money market  deposit                              |       | $                                        | 95,860     |   | $ | 829 |   | 1.16 | % | $ | 140,836 |   | $ | 966 |   | 0.92 | % |
| Savings deposit                                            |       | 377,491                                  |       | 4,030 |   | 1.43 |   | 307,109 |   | 2,275 |   | 0.99 |   |
| Time deposits                                              |       | 405,366                                  |       | 9,516 |   | 3.14 |   | 328,976 |   | 5,867 |   | 2.38 |   |
| Short-term borrowings                                      |       | 6,133                                    |       | 123 |   | 2.68 |   | 11,108 |   | 146 |   | 1.76 |   |
| Long-term borrowings                                       |       | 77,934                                   |       | 2,249 |   | 3.86 |   | 64,453 |   | 1,770 |   | 3.67 |   |
| Junior subordinated debt  owed to unconsolidated trusts    |       | 26,232                                   |       | 1,769 |   | 9.02 |   | 19,724 |   | 1,414 |   | 9.58 |   |
| Total interest bearing  liabilities                        |       | 989,016                                  |       | 18,516 |   | 2.50 |   | 872,206 |   | 12,438 |   | 1.90 |   |
| Demand deposits—non-interest  bearing                 |       | 35,434                                   |       |   |   |   |   | 51,970 |   |   |   |   |   |
| Other non-interest  bearing liabilities                    |       | 49,089                                   |       |   |   |   |   | 19,755 |   |   |   |   |   |
| Stockholders’ equity,  including stock owned by ESOP  |       | 73,560                                   |       |   |   |   |   | 69,641 |   |   |   |   |   |
| Total liabilities and  stockholders equity                 |       | $                                        | 1,147,099  |   |   |   |   |   | $ | 1,013,572 |   |   |   |   |   |
|                                                       |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  income/interest rate Spread(4)               |       |                                     |       | $ | 30,770 |   | 3.59 | % |   |   | $ | 27,559 |   | 3.77 | % |
|                                                       |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Net interest margin on a  fully tax equivalent basis(5)    |       |                                     |       |   |   | 3.80 | % |   |   |   |   | 3.91 | % |
|                                                       |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Net interest margin(5)                                     |       |                                     |       |   |   | 3.76 | % |   |   |   |   | 3.87 | % |

 

----

(1)                                  Includes non-accrualloans of $7.3 million and $3.3 million for the nine months ended September 30,2005 and 2004, respectively.

 

(2)                                  Interest incomeincludes loan origination fees of $2.4 million and $2.3 million for the ninemonths ended September 30, 2005 and 2004, respectively.

 

(3)                                  Non-taxableinvestment income is presented on a fully tax equivalent basis, adjusting forfederal and state exemption of interest income and certain other permanentincome tax differences.

 

(4)                                  Interest rate spreadrepresents the difference between the average yield on interest earning assetsand the average cost of interest bearing liabilities and is presented on afully tax equivalent basis.

 

(5)                                  Net interest marginrepresents net interest income as a percentage of average interest earningassets.

 

16

----

 

For the nine months ended September 30,2005, net interest income on a fully tax equivalent basis increased $3.2 million(11.7%) to $30.8 million from $27.6 million for the nine months ended September 30,2004.  The increase in net interestincome resulted from an increase in interest income on a fully tax equivalentbasis of $9.3 million (23.2%), which was partially offset by an increase ininterest expense of $6.1 million (48.9%). The increase in interest income on a fully tax equivalent basis wasmainly due to an increase in total interest earning assets of $141.4 million (15.0%),which accounted for $7.6 million of the increase.  The yield on interest earning assets alsoincreased 41 basis points, which increased interest income on a fully taxequivalent basis by $1.7 million.  Theincrease in interest expense was due to an increase in the yield on interestbearing liabilities of 60 basis points, which accounted for an increase ininterest expense of $3.5 million. In addition, average interest-bearingliabilities increased a total of $116.8 million (13.4%), which increasedinterest expense by $2.5 million.  Thenet interest margin expressed on a fully tax equivalent basis decreased 11basis points to 3.80% for 2005 from 3.91% for 2004.

 

***Volume, Mix and RateAnalysis of Net Interest Income.***  The following tables present the extent towhich changes in volume, changes in interest rates, and changes in the interestrates times the changes in volume of interest earning assets and interestbearing liabilities have affected our interest income and interest expenseduring the periods indicated. Information is provided on changes in eachcategory due to (i) changes attributable to changes in volume (change involume times the prior period interest rate), (ii) changes attributable tochanges in interest rate (changes in rate times the prior period volume) and (iii) changesattributable to changes in rate/volume (changes in interest rate times changesin volume).  Changes attributable to thecombined impact of volume and rate have been allocated proportionally to thechanges due to volume and the changes due to rate:

 
| ** **                                                | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                | ** ** | **2005 Compared to 2004**                 | ** ** | **2005 Compared to 2004**                | ** ** |
| ** **                                                | ** ** | **Change Due  to Volume**            | ** ** | **Change Due  to Rate**             | ** ** | **Total  Change** | ** ** | **Change Due  to Volume** | ** ** | **Change Due  to Rate** | ** ** | **Total  Change** | ** ** |
| ** **                                                | ** ** | **(In thousands)**                        | ** ** |
| **Interest  Earning Assets:**                             |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |
| Loans                                                     |       | $                                         | 3,038      |                                     | $          | 707 |   | $ | 3,745 |   | $ | 8,405 |   | $ | 1,143 |   | $ | 9,548 |   |
| Taxable investment securities                             |       | (273                                      | )          | 7                                        |       | (266 | ) | (791 | ) | 73 |   | (718 | ) |
| Investment securities exempt from federal income taxes(1) |       | 6                                         |       | 87                                       |       | 93 |   | (87 | ) | 219 |   | 132 |   |
| Federal  funds sold                                       |       | 1                                         |       | —                                   |       | 1 |   | 9 |   | — |   | 9 |   |
| Other interest bearing deposits                           |       | 123                                       |       | 154                                      |       | 277 |   | 18 |   | 289 |   | 307 |   |
| Investment in unconsolidated trust subsidiaries           |       | 8                                         |       | (1                                       | )          | 7 |   | 13 |   | (2 | ) | 11 |   |
| Total increase (decrease) in interest income              |       | 2,903                                     |       | 954                                      |       | 3,857 |   | 7,567 |   | 1,722 |   | 9,289 |   |
| **Interest Bearing Liabilities:**                         |       |                                      |       |                                     |       |   |   |   |   |   |   |   |   |
| NOW and money market deposit accounts                     |       | $                                         | (105       | )                                        | $          | 100 |   | $ | (5 | ) | $ | (353 | ) | $ | 216 |   | $ | (137 | ) |
| Savings  deposits                                         |       | 50                                        |       | 567                                      |       | 617 |   | 600 |   | 1,155 |   | 1,755 |   |
| Time  deposits                                            |       | 771                                       |       | 1,072                                    |       | 1,843 |   | 1,544 |   | 2,105 |   | 3,649 |   |
| Short-term  borrowings                                    |       | (51                                       | )          | —                                   |       | (51 | ) | (82 | ) | 59 |   | (23 | ) |
| Long-term  borrowings                                     |       | 228                                       |       | 46                                       |       | 274 |   | 385 |   | 94 |   | 479 |   |
| Junior subordinated debt owed to unconsolidated trusts    |       | 223                                       |       | (12                                      | )          | 211 |   | 443 |   | (88 | ) | 355 |   |
| Total increase (decrease) in interest expense             |       | 1,116                                     |       | 1,773                                    |       | 2,889 |   | 2,537 |   | 3,541 |   | 6,078 |   |
| Increase (decrease) in net interest income                |       | $                                         | 1,787      |                                     | $          | (819 | ) | $ | 968 |   | $ | 5,030 |   | $ | (1,819 | ) | $ | 3,211 |   |

 

----

(1)                                  Non-taxable investment income is presented ona fully tax equivalent basis, adjusting for federal and state exemption ofinterest income and certain other permanent income tax differences.

 

17

----

 

***Other Income.***  Changes in other income between the threemonths ended September 30, 2005 and 2004, and between the nine monthsended September 30, 2005 and 2004, were as follows:

 
| ** **                   | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | **Nine Months Ended**  | ** ** | ** ** | ** ** |
|------------------------------|------------|------------------------|------------|------------|------------|------------------------|------------|------------|------------|
| ** **                   | ** ** | **September 30,** | ** ** | **Net**    | ** ** | **September 30,** | ** ** | **Net**    | ** ** |
| ** **                   | ** ** | **2005**               | ** ** | **2004**   | ** ** | **difference**         | ** ** | **2005**   | ** ** | **2004** | ** ** | **difference** | ** ** |
| ** **                   | ** ** | **(In thousands)**     | ** ** |
| Other  income:               |       |                   |       |       |       |                   |       |       |       |   |   |   |   |
| Mortgage loan servicing fees |       | $                      | 681        |       | $          | 592                    |       | $          | 89         |   | $ | 1,942 |   | $ | 1,751 |   | $ | 191 |   |
| Loan and other fees          |       | 712                    |       | 590        |       | 122                    |       | 2,009      |       | 1,829 |   | 180 |   |
| Service charges on deposits  |       | 401                    |       | 377        |       | 24                     |       | 1,100      |       | 1,047 |   | 53 |   |
| Gain on sale of loans        |       | 665                    |       | 374        |       | 291                    |       | 1,766      |       | 2,373 |   | (607 | ) |
| Gain on sale of securities   |       | —                 |       | —     |       | —                 |       | —     |       | 272 |   | (272 | ) |
| Other operating income       |       | 414                    |       | 164        |       | 250                    |       | 809        |       | 692 |   | 117 |   |
|                         |       | $                      | 2,873      |       | $          | 2,097                  |       | $          | 776        |   | $ | 7,626 |   | $ | 7,964 |   | (338 | ) |
|                              |            |                        |            |            |            |                        |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

In the third quarter of 2005, other income increasedby $776 thousand (37.0%) to $2.9 million from $2.1 million in the third quarterof 2004.  Gain on sale of loans increased$291 thousand (77.8%) due to an increase in the sale of loans between September 30,2004 and September 30, 2005.  Titleinsurance premiums (included in “other operating income” above) increased $241thousand mainly due to additional business generated from Title Guaranty’s newSanta Fe office.

 

In the first nine months of 2005, other income decreased by $338thousand (4.2%) to $7.6 million from $8.0 million in the first nine months of2004.  Gain on sale of loans decreased $607thousand (25.6%) due to fewer loans being sold in the first nine months of 2005compared to the same period in 2004 (most of the loan sales in 2004 were duringthe first two quarters of the year, though in the third quarter of 2005 loansales exceeded the sales in the third quarter of 2004.)  Gain on sale of securities dropped $272thousand (100.0%) due to the lack of security sales in 2005.  Mortgage loan servicing fees increased $191thousand (10.9%) in the first nine months of 2005, partially due to an increasein fees from issuing letters of credit.  Loan and other fees increased $180 thousand(9.8%) largely due to an increase in ATM switch fees collected.

 

***Other Expenses.***  Changes in other expenses between the threemonths ended September 30, 2005 and 2004 and the nine months ended September 30,2005 and 2004 were as follows:

 
| ** **                                               | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | **Nine Months Ended**  | ** ** | ** ** | ** ** |
|----------------------------------------------------------|------------|------------------------|------------|------------|------------|------------------------|------------|------------|------------|
| ** **                                               | ** ** | **September 30,** | ** ** | **Net**    | ** ** | **September 30,** | ** ** | **Net**    | ** ** |
| ** **                                               | ** ** | **2005**               | ** ** | **2004**   | ** ** | **difference**         | ** ** | **2005**   | ** ** | **2004** | ** ** | **difference** | ** ** |
| ** **                                               | ** ** | **(In thousands)**     | ** ** |
| Other  expenses:                                         |       |                   |       |       |       |                   |       |       |       |   |   |   |   |
| Salaries and employee benefits                           |       | $                      | 4,038      |       | $          | 3,725                  |       | $          | 313        |   | $ | 12,059 |   | $ | 11,433 |   | $ | 626 |   |
| Occupancy                                                |       | 785                    |       | 660        |       | 125                    |       | 2,378      |       | 1,728 |   | 650 |   |
| Data processing                                          |       | 486                    |       | 508        |       | (22                    | )          | 1,391      |       | 1,442 |   | (51 | ) |
| Marketing                                                |       | 403                    |       | 433        |       | (30                    | )          | 1,133      |       | 983 |   | 150 |   |
| Amortization and valuation of mortgage  servicing rights |       | (162                   | )          | 1,230      |       | (1,392                 | )          | 902        |       | 1,120 |   | (218 | ) |
| Supplies                                                 |       | 159                    |       | 202        |       | (43                    | )          | 559        |       | 583 |   | (24 | ) |
| Loss (gain) on sale of other real estate  owned          |       | 123                    |       | (3         | )          | 126                    |       | 950        |       | 125 |   | 825 |   |
| Postage                                                  |       | 142                    |       | 143        |       | (1                     | )          | 452        |       | 416 |   | 36 |   |
| Other                                                    |       | 931                    |       | 911        |       | 20                     |       | 3,032      |       | 2,958 |   | 74 |   |
|                                                     |       | $                      | 6,905      |       | $          | 7,809                  |       | $          | (904       | ) | $ | 22,856 |   | $ | 20,788 |   | $ | 2,068 |   |

 

18

----

 

For the third quarter of 2005, other expensesdecreased $904 thousand (11.6%) to $6.9 million from $7.8 million in the third quarterof 2004.  This decrease was primarily dueto a decrease in the mortgage servicing rights impairment and amortization of $1.4million (113.2%), due to an increase in the valuation of mortgage servicingrights that resulted from a higher interest rate environment.  This was partially offset by an increase insalaries and employee benefits of $313 thousand (8.4%), mainly due to anincrease in compensation per employee.

 

Forthe nine months ended September 30, 2005, other expenses increased $2.1million (9.9%) to $22.9 million from $20.8 million in the first nine months of2004.  This increase was largely due toan increase on the sale of other real estate owned by $825 thousand (660.0%)due to the disposal of several residential real estate properties acquired inforeclosure during the third quarter of 2005. Occupancy expense increased by $650 thousand (37.6%) mainly due to expensesassociated with the new Santa Fe office, which was opened for nine months in2005 compared to just one month in 2004. Salaries and employee benefits also increased $626 thousand (5.5%),mainly due to an increase in compensation per employee.

 

***Income Taxes.***  In the third quarter of 2005, income taxexpense increased $1.1 million (92.2%) over the third quarter of 2004 to atotal of $2.2 million compared to $1.1 million. The effective tax rate increased to 39.5% in the third quarter of 2005,compared to 35% in the third quarter of 2004.

 

In the nine months ended September 30, 2005, income tax expensewas relatively flat from the same period in 2004, increasing $64 thousand (1.3%),remaining at a total of $4.9 million.  Theeffective tax rate decreased slightly to 37.7% in the first nine months of2005, compared to 38.1% in the first nine months of 2004.  This decrease was mainly attributable to thetax benefit from the exercise of stock options.

 

***Balance Sheet—General.***  Total assets at September 30, 2005 were at$1.2 billion, an increase of $142.5 million (13.2%) from December 31, 2004.  Net loans increased $109.7 million (12.4%)during 2005 and cash and cash equivalents increased by $62.7 million (263.5%).  This was partially offset by a decline ininvestments of $31.6 million (27.9%).  Duringthe same period, total liabilities increased $139.2 million (13.8%) to a totalof $1.1 billion on September 30, 2005, from $1.0 billion on December 31,2004.  The increase in total liabilitieswas primarily due to an increase in total deposits of $141.0 million (16.0%).  Stockholders’ equity (including stock ownedby the Employee Stock Ownership Plan) increased $3.3 million (4.5%) to $76.2million on September 30, 2005 compared to $73.0 million on December 31,2004.

 

***InvestmentSecurities.*** The primary purposes of the investment portfolio are to provide a sourceof earnings for liquidity management purposes, to provide collateral to pledgeagainst public deposits and to control interest rate risk. In managing theportfolio, we seek to obtain the objectives of safety of principal, liquidity,diversification and maximized return on funds. For an additional discussionwith respect to these matters, see “Liquidity” and “Capital Resources” underItem 2 and “Asset Liability Management” under Item 3 below.

 

19

----

 

The following tables set forth the amortizedcost and fair value of our securities by accounting classification category andby type of security as indicated:

 
| ** **                                                       | ** ** | **At September 30, 2005** | ** ** | **At December 31, 2004** | ** ** | **At September 30, 2004** | ** ** |
|------------------------------------------------------------------|------------|--------------------------------|------------|-------------------------------|------------|--------------------------------|------------|
| ** **                                                       | ** ** | **Amortized Cost**             | ** ** | **Fair Value**                | ** ** | **Amortized Cost**             | ** ** | **Fair Value** | ** ** | **Amortized Cost** | ** ** | **Fair Value** | ** ** |
| ** **                                                       | ** ** | **(In thousands)**             | ** ** |
| Securities  Available for Sale:                                  |       |                           |       |                          |       |                           |       |   |   |   |   |   |   |
| U.S. Government agencies                                         |       | $                              | 35,146     |                          | $          | 34,789                         |       | $ | 42,218 |   | $ | 41,907 |   | $ | 47,341 |   | $ | 47,290 |   |
| States and political subdivisions                                |       | 5,995                          |       | 5,967                         |       | 2,210                          |       | 2,191 |   | 2,221 |   | 2,216 |   |
| Equity securities                                                |       | 1                              |       | 4                             |       | 1                              |       | 7 |   | 1 |   | 6 |   |
| Total securities available for sale                              |       | $                              | 41,142     |                          | $          | 40,760                         |       | $ | 44,429 |   | $ | 44,105 |   | $ | 49,563 |   | $ | 49,512 |   |
|                                                             |       |                           |       |                          |       |                           |       |   |   |   |   |   |   |
| Securities  Held to Maturity:                                    |       |                           |       |                          |       |                           |       |   |   |   |   |   |   |
| U.S. Government agencies                                         |       | $                              | 19,760     |                          | $          | 19,719                         |       | $ | 46,547 |   | $ | 46,705 |   | $ | 52,723 |   | $ | 53,223 |   |
| States and political subdivisions                                |       | 13,120                         |       | 13,127                        |       | 15,111                         |       | 15,178 |   | 15,297 |   | 15,407 |   |
| Total securities held to maturity                                |       | $                              | 32,880     |                          | $          | 32,846                         |       | $ | 61,658 |   | $ | 61,883 |   | $ | 68,020 |   | $ | 68,630 |   |
|                                                             |       |                           |       |                          |       |                           |       |   |   |   |   |   |   |
| Other  securities:                                               |       |                           |       |                          |       |                           |       |   |   |   |   |   |   |
| Non-marketable equity securities (including  FRB and FHLB stock) |       | $                              | 7,016      |                          | $          | 7,016                          |       | $ | 6,798 |   | $ | 6,798 |   | $ | 6,573 |   | $ | 6,573 |   |
| Investment in unconsolidated trusts                              |       | 992                            |       | 992                           |       | 682                            |       | 682 |   | 682 |   | 682 |   |
| Total other securities                                           |       | $                              | 8,008      |                          | $          | 8,008                          |       | $ | 7,480 |   | $ | 7,480 |   | $ | 7,255 |   | $ | 7,255 |   |

 

***Loan Portfolio.***  The following tables set forth thecomposition of the loan portfolio:

 
| ** **                 | ** ** | **At  September 30, 2005** | ** ** | **At  December 31, 2004** | ** ** | **At  September 30, 2004** | ** ** |
|----------------------------|------------|---------------------------------|------------|--------------------------------|------------|---------------------------------|------------|
| ** **                 | ** ** | **Amount**                      | ** ** | **Percent**                    | ** ** | **Amount**                      | ** ** | **Percent** | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| ** **                 | ** ** | **(Dollars  in thousands)**     | ** ** |
| Commercial                 |       | $                               | 90,837     |                           | 9.01       | %                               | $          | 92,736 |   | 10.35 | % | $ | 85,439 |   | 10.05 | % |
| Commercial real  estate    |       | 383,149                         |       | 38.02                          |       | 346,454                         |       | 38.65 |   | 335,236 |   | 39.45 |   |
| Residential real  estate   |       | 314,061                         |       | 31.17                          |       | 282,380                         |       | 31.50 |   | 261,535 |   | 30.77 |   |
| Construction real  estate  |       | 165,195                         |       | 16.39                          |       | 121,769                         |       | 13.59 |   | 116,417 |   | 13.70 |   |
| Installment and  other     |       | 54,471                          |       | 5.41                           |       | 52,984                          |       | 5.91 |   | 51,260 |   | 6.03 |   |
| Total loans                |       | 1,007,713                       |       | 100.00                         |       | 896,323                         |       | 100.00 |   | 849,887 |   | 100.00 |   |
| Unearned income            |       | (2,216                          | )          |                           |       | (2,002                          | )          |   |   | (1,958 | ) |   |   |
| Gross loans                |       | 1,005,497                       |       |                           |       | 894,321                         |       |   |   | 847,929 |   |   |   |
| Allowance for  loan losses |       | (9,850                          | )          |                           |       | (8,367                          | )          |   |   | (8,554 | ) |   |   |
| Net loans                  |       | $                               | 995,647    |                           |       |                            | $          | 885,954 |   |   |   | $ | 839,375 |   |   |   |

 

Total loans increased $157.8 million (18.6%) to $1.0 billion at September 30,2005 from $849.9 million at September 30, 2004. The increase was dueprimarily to growth in the Company’s residential, construction, and commercialreal estate loan portfolios as the percentage levels of the categories of loanswithin the portfolio remained relatively constant.  The strong loan growth was due to marketconditions combined with the additional activity generated from the company’ssecond Santa Fe office, opened in August 2004.

 

20

----

 

***Asset Quality.***  The following table sets forth the amounts ofnon-performing loans and non-performing assets at the dates indicated:

 
| ** **                                                    | ** ** | **At September 30,  2005** | ** ** | **At December 31,  2004** | ** ** | **At September 30,  2004** | ** ** |
|---------------------------------------------------------------|------------|---------------------------------|------------|--------------------------------|------------|---------------------------------|------------|
| ** **                                                    | ** ** | **(Dollars in Thousands)**      | ** ** |
| Non-accruing  loans                                           |       | $                               | 11,587     |                           | $          | 5,714                           |       | $ | 3,391 |   |
| Loans  90 days or more past due, still accruing interest |       | 69                              |       | 8                              |       | 12                              |       |
| Total  non-performing loans                                   |       | 11,656                          |       | 5,722                          |       | 3,403                           |       |
| Other real  estate owned                                      |       | 330                             |       | 6,438                          |       | 6,728                           |       |
| Other  repossessed assets                                     |       | 24                              |       | 64                             |       | 68                              |       |
| Total  non-performing assets                                  |       | $                               | 12,010     |                           | $          | 12,224                          |       | $ | 10,199 |   |
|                                                          |       |                            |       |                           |       |                            |       |
| Total  non-performing loans to total loans                    |       | 1.16                            | %          | 0.64                           | %          | 0.40                            | %          |
| Allowance  for loan losses to non-performing loans            |       | 84.5                            | %          | 146.23                         | %          | 251.40                          | %          |
| Total  non-performing assets to total assets                  |       | 0.98                            | %          | 1.13                           | %          | 0.95                            | %          |
|                                                               |            |                                 |            |                                |            |                                 |            |  |  |  |  |  |

 

At September 30, 2005, total non-performing assets increased $1.8million (17.8%) to $12.0 million from $10.2 million at September 30, 2004due to increases in non-accruing loans of $8.2 million (241.7%), which was largelyoffset by a decrease in other real estate owned of $6.4 million (95.1%).  The increase in non-accrual loans was duemainly to $5.8 million in commercial loans to one borrower being placed onnon-accrual status in June of 2005. This loan is collateralized by commercial property, constructionequipment and accounts receivable. Management has allocated $2.0 million of the allowance for loan losses forthese loans in the event that the customer will not be able to fully repay.  The decrease in other real estate owned wasprimarily due to the sale of $5.8 million in residential real estate andresidential construction property in 2005.

 

At September 30, 2005, total non-performing assets decreased $214thousand (1.8%) to $12.0 million from $12.2 million at December 31, 2004primarily due to increases in non-accruing loans of $5.9 million, as discussedabove, which was largely offset by a decrease in other real estate owned of $6.1million.  The decrease in other realestate owned was primarily due to the sale of $5.8 million in residential realestate and residential construction property in 2005.

 

*Allowance for Loan Losses.* Management believes the allowance forloan losses accounting policy is critical to the portrayal and understanding ofthe Company’s financial condition and results of operations. As such, selectionand application of this “critical accounting policy” involves judgments,estimates, and uncertainties that are susceptible to change. In the event thatdifferent assumptions or conditions were to prevail, and depending upon theseverity of such changes, the possibility of materially different financialcondition or results of operations is a reasonable likelihood.

 

The allowance for loan losses is maintained at an amount thatmanagement believes will be adequate to absorb probable losses on existingloans, based on an evaluation of the collectibility of loans and prior lossexperience. This evaluation also takes into consideration such factors aschanges in the nature and volume of the loan portfolio, the value of underlyingcollateral, overall portfolio quality, review of specific problem loans andcurrent economic conditions that may affect the borrower’s ability to pay.While management uses the best information available to make its evaluation,future adjustments to the allowance may be necessary if there are significantchanges in economic conditions. In addition, as an integral part of theirexamination process regulatory agencies periodically review the Company’sallowance for loan losses and may require the Company to make additions to theallowance based on their evaluation of information available at the time oftheir examinations.

 

21

----

 

The following table presents an analysis ofthe allowance for loan losses for the periods presented:

 
| ** **                                     | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                     | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                     | ** ** | **(Dollars in thousands)**                 | ** ** |
| Balance at  beginning of period                |       | $                                          | 9,364      |                                      | $          | 8,289 |   | $ | 8,367 |   | $ | 7,368 |   |
| Provision  for loan losses                     |       | 750                                        |       | 450                                       |       | 2,100 |   | 1,650 |   |
| Total  charge-offs                             |       | (311                                       | )          | (308                                      | )          | (740 | ) | (603 | ) |
| Total  recoveries                              |       | 47                                         |       | 123                                       |       | 123 |   | 139 |   |
| Net  charge-offs                               |       | (264                                       | )          | (185                                      | )          | (617 | ) | (464 | ) |
| Balance at  end of period                      |       | $                                          | 9,850      |                                      | $          | 8,554 |   | $ | 9,850 |   | $ | 8,554 |   |
|                                           |       |                                       |       |                                      |       |   |   |   |   |   |   |   |   |
| Gross loans  at end of period                  |       | $                                          | 1,005,497  |                                      | $          | 847,929 |   | $ | 1,005,497 |   | $ | 847,929 |   |
| Ratio of  allowance to total loans             |       | 0.98                                       | %          | 1.01                                      | %          | 0.98 | % | 1.01 | % |
| Ratio of net charge-offs to average loans  (1) |       | 0.10                                       | %          | 0.09                                      | %          | 0.09 | % | 0.08 | % |

 

----

(1)                                  Net charge-offs areannualized for the purposes of this calculation.

 

Net charge-offs for the three months ended September 30, 2005totaled $264 thousand, an increase of $79 thousand (42.7%) from $185 thousand forthe three months ended September 30, 2004. The majority of the charge-offs were installment and commercialloans.  The provision for loan losses increasedby $300 thousand (66.7%) for the three months ended September 30, 2005,due to management’s analysis of current non-performing loans.

 

Net charge-offs for the nine months ended September 30, 2005totaled $617 thousand, an increase of $153 thousand (33.0%) from $464 thousandfrom the nine months ended September 30, 2004.  The majority of the charge-offs were installmentand commercial loans.  The provision forloan losses increased by $450 thousand (27.3%) for the nine months ended September 30,2005, due to management’s analysis of current non-performing loans.

 

The following table sets forth the allocation of the allowance for loanlosses for the periods presented and the percentage of loans in each categoryto total loans. An allocation for a loan classification is only for internalanalysis of the adequacy of the allowance and is not an indication of expectedor anticipated losses:

 
| ** **                             | ** ** | **At September 30, 2005** | ** ** | **At December 31, 2004** | ** ** | **At September 30, 2004** | ** ** |
|----------------------------------------|------------|--------------------------------|------------|-------------------------------|------------|--------------------------------|------------|
| ** **                             | ** ** | **Amount**                     | ** ** | **Percent**                   | ** ** | **Amount**                     | ** ** | **Percent** | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| ** **                             | ** ** | **(Dollars in thousands)**     | ** ** |
| Commercial                             |       | $                              | 3,681      |                          | 9.01       | %                              | $          | 3,502 |   | 10.35 | % | $ | 1,998 |   | 10.05 | % |
| Commercial and residential real estate |       | 3,513                          |       | 69.19                         |       | 2,511                          |       | 70.15 |   | 3,363 |   | 70.22 |   |
| Construction real estate               |       | 1,842                          |       | 16.39                         |       | 981                            |       | 13.59 |   | 1,193 |   | 13.70 |   |
| Installment and other                  |       | 802                            |       | 5.41                          |       | 1,369                          |       | 5.91 |   | 1,978 |   | 6.03 |   |
| Unallocated                            |       | 12                             |       | N/A                           |       | 4                              |       | N/A |   | 22 |   | N/A |   |
| Total                                  |       | $                              | 9,850      |                          | 100.00     | %                              | $          | 8,367 |   | 100.00 | % | $ | 8,554 |   | 100.00 | % |

 

----

N/A—not applicable

 

22

----

 

The portion of the allocation that was basedupon historical loss experience decreased by $1.4 million (37.8%) in 2005, from$3.7 million on December 31, 2004 to $2.3 million on September 30,2005.  This was largely due to a decreasein the allocation for commercial loans which decreased by $1.7 million and theallocation for installment and other loans which decreased by $862 thousand.  This was partially offset by an increase inthe allocation for commercial and residential real estate of $1.1 million.  These changes were due to a change in thelosses we actually experienced during the nine months ended September 30,2005.  Historical loss allocation declined$553 thousand (19.5%) from September 30, 2004 to September 30, 2005   This was mainly due to a decrease in theallocation for installment and other loans of $1.3 million and the allocationfor commercial loans of $421 thousand, which was largely offset by an increasein the allocation for commercial and residential real estate of $1.1 million.  Concentration allocation was relativelyunchanged from December 31, 2005 to September 30, 2005, remaining at$5.1 million.  From September 30,2004 to September 30, 2005, the concentration allocation decreasedslightly, by $243 thousand (4.5%). Concentration allocation was relativelyunchanged due to little change in the actual loan concentrations of the Bank.  From December 31, 2004 to September 30,2005, the allocation for specifically identified loans increased, from $446 thousandto $2.4 million, an increase of $2.0 million (438.1%).  From September 30, 2004 to September 30,2005, the allocation for specifically identified loans increased $2.1 million (607.7%).  These increases were largely due to anallocation for $2.0 million being made in June of 2005 for a singleborrower, as discussed above.

 

Managementanticipates continued growth in the loan portfolio due to a strong localeconomy, an expected Los Alamos National Laboratory budget of over $2 billionand continued new home construction and expansion in Santa Fe.  The volume of commercial real estate andconstruction loans is also anticipated to increase as the industry continues tostrengthen and the recovery in capital spending boosts production and profitsin 2005.  Although record mortgage financingpeaked in 2003, the housing market for new construction and resale homes isexpected to remain strong, especially in the under $500 thousand market, whichshould remain constant.  Residential realestate for property worth greater than $1.5 million is expected to be as “soft”as during the last several years.

 

Additions to the allowance for loan losses, which are charged toearnings through the provision for loan losses, are determined based on avariety of factors, as indicated above. Although management believes the allowance for loan losses is sufficientto cover probable losses inherent in the loan portfolio, there can be noassurance that the allowance will prove sufficient to cover actual future loanlosses.

 

*Potential Problem Loans.*  The Company utilizes an internal assetclassification system as a means of reporting problem and potential problemassets.  At scheduled Board of Directorsmeetings every quarter, a list of total adversely classified assets ispresented, showing other real estate owned, other repossessed assets, and allloans listed as “Substandard,” “Doubtful” and “Loss.”  All non-accrual loans are classed either as “Substandard”or “Doubtful” and are thus included in total adversely classified assets.  A separate watch list of loans classified as “SpecialMention” is also presented.  An asset isclassified Substandard if it is inadequately protected by the current net worthand paying capacity of the obligor and/or of the collateral pledged, if any.Substandard assets include those characterized by the distinct possibility thatthe Company will sustain some loss if the deficiencies are not corrected.  Assets classified as Doubtful have all theweaknesses inherent in those classified Substandard with the addedcharacteristic that the weaknesses present make collection or liquidation infull, on the basis of currently existing facts, conditions and values, highlyquestionable and improbable.  Assetsclassified as Loss are those considered uncollectible and viewed asnon-bankable assets, worthy of charge-off. Assets that do not currently expose the Company to sufficient risk towarrant classification in one of the aforementioned categories, but possessweaknesses that may or may not be within the control of the customer are deemedto be Special Mention.

 

The Company’s determination as to the classification of its assets andthe amount of its valuation allowances is subject to review by the Bank’sprimary regulators, which can order the establishment of additional general orspecific loss allowances.  TheComptroller of the Currency, in conjunction with the other federal bankingagencies, has adopted an interagency policy statement on the allowance for loanlosses.  The policy statement providesguidance for financial institutions on both the responsibilities of managementfor the assessment and establishment of adequate allowances and guidance forbanking agency examiners to use in determining the adequacy of generalvaluation guidelines.  Generally, thepolicy statement recommends that (i) institutions have effective systems andcontrols to identify, monitor and address asset quality problems; (ii) managementhas analyzed all significant factors that affect the collectibility of theportfolio in a reasonable manner; and (iii) management has establishedacceptable allowance evaluation processes that meet the objectives set forth inthe policy statement.  Managementbelieves it has established an adequate allowance for probable loanlosses.  The Company analyzes its processregularly, with modifications made if needed, and reports those resultsquarterly at Board of Directors meetings. However, there can be no assurance that regulators, in reviewing theCompany’s loan portfolio, will not request the Company to materially increaseits allowance for loan losses at a future time. Although management believes that adequate specific and general loanloss allowances have been established, actual losses are dependent upon futureevents and, as such, further additions to the level of specific and generalloan loss allowances may become necessary.

 

23

----

 

The following table shows the amounts ofadversely classified assets and special mention loans as of the periodsindicated:

 
| ** **                         | ** ** | **At September 30,**

**2005** | ** ** | **At December 31,  2004** | ** ** | **At September 30,  2004** | ** ** |
|------------------------------------|------------|-------------------------------------|------------|--------------------------------|------------|---------------------------------|------------|
| ** **                         | ** ** | **(Dollars in thousands)**          | ** ** |
| Loans  classified as:              |       |                                |       |                           |       |                            |       |
| Substandard                        |       | $                                   | 19,794     |                           | $          | 15,810                          |       | $ | 12,734 |   |
| Doubtful                           |       | 1,319                               |       | 201                            |       | 218                             |       |
| Total  adversely classified loans  |       | 21,113                              |       | 16,011                         |       | 12,952                          |       |
| Other real  estate owned           |       | 330                                 |       | 6,438                          |       | 6,728                           |       |
| Other repossessed  assets          |       | 24                                  |       | 64                             |       | 68                              |       |
| Total  adversely classified assets |       | $                                   | 21,467     |                           | $          | 22,513                          |       | $ | 19,748 |   |
|                               |       |                                |       |                           |       |                            |       |
| Special  mention loans             |       | $                                   | 15,854     |                           | $          | 22,834                          |       | $ | 17,673 |   |

 

Total adversely classified assets increased $1.7 million (8.7%) from September 30,2004 to September 30, 2005.  Themain reason for the increase was an increase of $7.1 million in loansclassified as substandard and an increase of $1.1 million in loans classifiedas doubtful, which was partially offset by a decrease in other real estateowned of $6.4 million.  The increase inloans classified as substandard was due mainly to one large borrowingrelationship being downgraded.  Theincrease in loans classified as doubtful was mainly due to the samerelationship downgrade. The decrease in other real estate owned was primarilydue to the sale of $5.8 million in residential real estate and residentialconstruction property in 2005.  Specialmention loans decreased $1.8 million (10.3%) from September 30, 2004 to September 30,2005, primarily due to several loans having been upgraded to pass and someloans having been downgraded further to substandard.

 

**Sources of Funds**

 

***Liquidity andSources of Capital***

 

The Company’s cash flows are comprised ofthree classifications: cash flows from operating activities, cash flows frominvesting activities and cash flows from financing activities. Net cashprovided by operating activities was $6.9 million and $12.7 million for the ninemonths ended September 30, 2005 and 2004, respectively.  Net cash provided by operating activities decreased$5.8 million in the first nine months of 2005 compared to the first nine monthsof 2004 largely due to a decline in the gross sales of loans held for sale by $39.4million over the first nine months of 2004, which was partially offset by theorigination of loans held for sale that decreased $33.2 million in the sameperiod.  Net cash used in investingactivities was $(77.0) million and $(66.5) million for the nine months ended September 30,2005 and 2004, respectively.  The $10.5million increase in cash used in investing activities was largely due to thedecrease of $28.4 million in the proceeds from the sale of investmentsecurities and the decrease of $14.5 million in the proceeds from thematurities and paydowns of investment securities.  This was partially offset by a decrease of$24.6 million in cash used for the purchases of investment securities and adecrease of $6.8 million in cash used for the purchase of premises andequipment.  Net cash provided byfinancing activities was $132.9 million and $59.7 million for the nine monthsended September 30, 2005 and 2004, respectively.  The $73.2 million increase in cash providedby financing activities was mainly due to an increase in new deposit growth of$108.5 million in the first nine months of 2005 compared to the first ninemonths of 2004.  This was partiallyoffset by a decrease in cash provided by net borrowings activity of $35.8million.

 

TheCompany expects to have available cash to meet its liquidity needs. Liquidity management is monitored by the Asset/Liability Committee of the Bank,which takes into account the marketability of assets, the sources and stabilityof funding and the level of unfunded commitments.  In the event that additional short-termliquidity is needed, the Company has established relationships with severallarge regional banks to provide short-term borrowings in the form of federalfunds purchases.  The Company hasborrowed, and management believes that the Company could again borrow, up to $94.0 millionfor a short time from these banks on a collective basis.  Additionally, the Bank is a member of theFederal Home Loan Bank (“FHLB”) and has the ability to borrow from theFHLB.  As a contingency plan forsignificant funding needs, the Asset/Liability committee may also consider thesale of investment securities, selling securities under agreement torepurchase, sale of certain loans and/or the temporary curtailment of lendingactivities.

 

At September 30, 2005, theCompany’s total risk-based capital ratio was 11.93%, the Tier 1 capital torisk-weighted assets ratio was 10.27%, and the Tier 1 capital to average assetsratio was 8.51%.  At December 31,2004, the Company’s total risk-based capital ratio was 11.59%, the Tier 1capital to risk-weighted assets ratio was 10.65%, and the Tier 1 capital toaverage assets ratio was 8.87%.

 

24

----

 

AtSeptember 30, 2005, the Bank’s total risk-based capital ratio was 11.46%,the Tier 1 capital to risk-weighted assets ratio was 10.46%, and the Tier 1capital to average assets ratio was 8.66%. At December 31, 2004, the Bank’s total risk-based capital ratio was10.78%, the Tier 1 capital to risk-weighted assets ratio was 9.83%, and theTier 1 capital to average assets ratio was 8.19%.  The Bank was categorized as “well-capitalized”under Federal Deposit Insurance Corporation regulations at September 30,2005 and December 31, 2004.

 

At September 30, 2005 and December 31,2004, the Company’s book value per common share was $11.50 and $10.84,respectively.

 

**Item 3. Quantitative and Qualitative Disclosures About Market Risk**

 

**Asset Liability Management**

 

The Company’s net interest income is subject to “interest rate risk” tothe extent that it can vary based on changes in the general level of interestrates. It is the Company’s policy to maintain an acceptable level of interestrate risk over a range of possible changes in interest rates while remainingresponsive to market demand for loan and deposit products.  The strategy employed by the Company tomanage its interest rate risk is to measure its risk using an asset/liabilitysimulation model and adjust the maturity of securities in its investmentportfolio to manage that risk.

 

Interest rate risk can also be measured by analyzing the extent towhich the repricing of assets and liabilities are mismatched to create aninterest sensitivity “gap”.  An asset orliability is said to be interest rate sensitive within a specific time periodif it will mature or reprice within that time period.  The interest rate sensitivity gap is definedas the difference between the amount of interest earning assets maturing orrepricing within a specific time period and the amount of interest bearingliabilities maturing or repricing within that same time period.  A gap is considered positive when the amountof interest rate sensitive assets exceeds the amount of interest rate sensitiveliabilities.  A gap is considered negativewhen the amount of interest rate sensitive liabilities exceeds the amount ofinterest rate sensitive assets.  During aperiod of rising interest rates, therefore, a negative gap would tend toadversely affect net interest income. Conversely, during a period of falling interest rates, a negative gapposition would tend to result in an increase in net interest income.

 

The following table sets forth the amounts of interest earning assetsand interest bearing liabilities outstanding at September 30, 2005, whichare anticipated by the Company, based upon certain assumptions, to reprice ormature in each of the future time periods shown. Except as stated below, theamount of assets and liabilities shown which reprice or mature during aparticular period were determined based on the earlier of the term to repricingor the term to repayment of the asset or liability.  The table is intended to provide anapproximation of the projected repricing of assets and liabilities at September 30,2005 on the basis of contractual maturities and scheduled rate adjustmentswithin a three-month period and subsequent selected time intervals.  The loan amounts in the table reflectprincipal balances expected to be reinvested and/or repriced as a result ofcontractual amortization and rate adjustments on adjustable-rate loans. Loanand investment securities contractual maturities and amortization reflectmodest prepayment assumptions.  WhileNOW, money market and savings deposit accounts have adjustable rates, it isassumed that the interest rates on these accounts will not adjust immediatelyto changes in other interest rates. Therefore, the table is calculated assuming that these accounts willreprice based upon an historical analysis of rate changes of these particularaccounts, with repricing assigned to these accounts from one to thirteenmonths.

 

25

----

 
| ** **                                              | ** ** | **Time to Maturity or Repricing** | ** ** |
|---------------------------------------------------------|------------|-----------------------------------|------------|
| **As of September 30, 2005:**                      | ** ** | **0-90 Days**                     | ** ** | **91-365 Days** | ** ** | **1-5 Years** | ** ** | **Over 5 Years** | ** ** | **Total** | ** ** |
| ** **                                              | ** ** | **(In thousands)**                | ** ** |
| **Interest  Earning Assets:**                           |       |                              |       |   |   |   |   |   |   |   |   |
| Loans                                                   |       | $                                 | 492,851    |   | $ | 422,014 |   | $ | 61,980 |   | $ | 28,652 |   | $ | 1,005,497 |   |
| Loans held  for sale                                    |       | 15,666                            |       | — |   | — |   | — |   | 15,666 |   |
| Investment  securities                                  |       | 19,385                            |       | 38,409 |   | 15,385 |   | 7,477 |   | 80,656 |   |
| Securities  purchased under agreements to resell        |       | 655                               |       | — |   | — |   | — |   | 655 |   |
| Interest  bearing deposits with banks                   |       | 62,211                            |       | — |   | — |   | — |   | 62,211 |   |
| Investment  in unconsolidated trusts                    |       | 186                               |       | — |   | — |   | 806 |   | 992 |   |
| Total interest earning assets                           |       | $                                 | 590,954    |   | $ | 460,423 |   | $ | 77,365 |   | $ | 36,935 |   | $ | 1,165,677 |   |
|                                                    |       |                              |       |   |   |   |   |   |   |   |   |
| **Interest  Bearing Liabilities:**                      |       |                              |       |   |   |   |   |   |   |   |   |
| NOW and  money market deposit accounts                  |       | $                                 | 122,581    |   | $ | 110,086 |   | — |   | — |   | $ | 232,667 |   |
| Savings  deposits                                       |       | 92,200                            |       | 153,067 |   | 7,386 |   | — |   | 252,653 |   |
| Time  deposits                                          |       | 108,470                           |       | 234,932 |   | 76,393 |   | 24,046 |   | 443,841 |   |
| Short- and  long-term borrowings                        |       | 1,956                             |       | 5,986 |   | 21,026 |   | 55,293 |   | 84,261 |   |
| Borrowings  made by ESOP to outside parties             |       | 1,214                             |       | — |   | — |   | — |   | 1,214 |   |
| Junior  subordinated debt owed to unconsolidated trusts |       | 6,186                             |       | — |   | — |   | 28,806 |   | 34,992 |   |
| Total interest bearing liabilities                      |       | $                                 | 332,607    |   | $ | 504,071 |   | $ | 104,805 |   | $ | 108,145 |   | $ | 1,049,628 |   |
|                                                    |       |                              |       |   |   |   |   |   |   |   |   |
| Rate  sensitive assets (RSA)                            |       | $                                 | 590,954    |   | $ | 1,051,377 |   | $ | 1,128,742 |   | $ | 1,165,677 |   | $ | 1,165,677 |   |
| Rate  sensitive liabilities (RSL)                       |       | 332,607                           |       | 836,678 |   | 941,483 |   | 1,049,628 |   | 1,049,628 |   |
| Cumulative  GAP (GAP=RSA-RSL)                           |       | 258,347                           |       | 214,699 |   | 187,259 |   | 116,049 |   | 116,049 |   |
| RSA/Total  assets                                       |       | 48.33                             | %          | 85.98 | % | 92.30 | % | 95.32 | % | 95.32 | % |
| RSL/Total  assets                                       |       | 27.20                             | %          | 68.42 | % | 76.99 | % | 85.83 | % | 85.83 | % |
| GAP/Total  assets                                       |       | 21.13                             | %          | 17.56 | % | 15.31 | % | 9.49 | % | 9.49 | % |
| GAP/RSA                                                 |       | 43.72                             | %          | 20.42 | % | 16.59 | % | 9.96 | % | 9.96 | % |

 

Certain shortcomings are inherent in the method of analysis presentedin the foregoing table. For example, although certain assets and liabilitiesmay have similar maturities or periods to repricing, they may react indifferent degrees to changes in market interest rates. Also, the interest rateson certain types of assets and liabilities may fluctuate in advance of changesin market interest rates, while interest rates on other types of assets may lagbehind changes in market rates. Additionally, in the event of a change in interest rates, prepayment andearly withdrawal levels would likely deviate significantly from those assumedin calculating the table.  Therefore, theCompany does not rely solely on a gap analysis to manage its interest raterisk, but rather it uses what it believes to be the more reliable simulationmodel relating to changes in net interest income as set forth below.

 

Changes in net interest income between the periods below reflectchanges in the composition of interest earning assets and interest bearingliabilities, related interest rates, repricing frequencies, and the fixed orvariable characteristics of the interest earning assets and interest bearingliabilities.  Projections of income givenby the model are not actual predictions, but rather show our relative interestrate risk.  Actual interest income mayvary from model projections.  Based onsimulation modeling at September 30, 2005 and December 31, 2004, theCompany’s net interest income would change over a one-year time period due tochanges in interest rates as follows:

 

**Change in Net Interest Income Over One YearHorizon**

 
| **Changes  in Levels of** | ** ** | **At September 30, 2005** | ** ** | **At December 31, 2004** | ** ** |
|---------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| **Interest  Rates**       | ** ** | **Dollar Change**              | ** ** | **Percentage Change**         | ** ** | **Dollar Change** | ** ** | **Percentage Change** | ** ** |
| ** **                | ** ** | **(Dollars in thousands)**     | ** ** |
| + 2.00                    | %          | $                              | (4,436     | )                             | (10.41     | )% | $ | (5,183 | ) | (13.25 | )% |
| + 1.00                    |       | (3,677                         | )          | (8.63                         | )          | (2,030 | ) | (5.19 | ) |
| (1.00                     | )          | (852                           | )          | (2.00                         | )          | 595 |   | 1.52 |   |
| (2.00                     | )          | (2,991                         | )          | (7.02                         | )          | 78 |   | 0.20 |   |
|                           |            |                                |            |                               |            |  |  |  |  |  |  |

 

Simulations used by the Company assume the following:

 

26

----

 

1.                                       Changes ininterest rates are immediate.

 

2.                                       It is theCompany’s policy that interest rate exposure due to a 2.00% interest rate riseor fall be limited to 15.0% of the Company’s annual net interest income, asforecasted by the simulation model. As demonstrated by the table above, theCompany’s interest rate risk exposure was within this policy at September 30,2005.

 

**Item 4.  Controls and Procedures.**

 

Evaluationof Disclosure Controls and Procedures: An evaluation of our disclosure controls and procedures (as definedin Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Act”))was carried out as of September 30, 2005 under the supervision and withthe participation of our Chief Executive Officer, Chief Financial Officer andseveral other members of our senior management. Our Chief Executive Officer and Chief Financial Officer concluded that,as of September 30, 2005, our disclosure controls and procedures wereeffective in ensuring that the information we are required to disclose in thereports we file or submit under the Act is (i) accumulated andcommunicated to our management (including the Chief Executive Officer and ChiefFinancial Officer) in a timely manner, and (ii) recorded, processed,summarized and reported within the time periods specified in the SEC’s rules andforms.

 

Changes in Internal Control Over Financial Reporting: During the quarter ended September 30,2005, no change occurred in our internal control over financial reporting thathas materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

 

Wedo not expect that our disclosure controls and procedures and internal controlover financial reporting will prevent all error and all fraud. A controlprocedure, no matter how well conceived and operated, can provide onlyreasonable, not absolute, assurance that the objectives of the controlprocedure are met. Because of the inherent limitations in all controlprocedures, no evaluation of controls can provide absolute assurance that allcontrol issues and instances of fraud, if any, within the Company have beendetected. These inherent limitations include the realities that judgments in decision-makingcan be faulty, and that breakdowns in controls or procedures can occur becauseof simple error or mistake. Additionally, controls can be circumvented by theindividual acts of some persons, by collusion of two or more people, or bymanagement override of the control. The design of any control procedure also isbased in part upon certain assumptions about the likelihood of future events,and there can be no assurance that any design will succeed in achieving itsstated goals under all potential future conditions; over time, controls maybecome inadequate because of changes in conditions, or the degree of compliancewith the policies or procedures may deteriorate. Because of the inherentlimitations in a cost-effective control procedure, misstatements due to erroror fraud may occur and not be detected.

 

27

----

 

**PART II – OTHER INFORMATION**

 

**Item 1.****     ****Legal Proceedings**

 

Neither Trinity, theBank nor Title Guaranty are involved in any pending legal proceedings which, inthe opinion of management, in the aggregate, are material to our consolidatedfinancial condition.

 

**Item 2.****      Unregistered Sales of Equity Securities and Useof Proceeds**

 

None

 

**Item 3.****     ****Defaults Upon Senior Securities**

 

None

 

**Item 4.****     ****Submission of Matters to a Vote of Security Holders**

 

None

 

**Item 5.****     ****Other Information**

 

None

 

**Item 6.****     ****Exhibits**

 

31.1       Certification of Chief Executive OfficerPursuant to Rule 13a-14(a)/15d-14(a)

31.2       Certification of Chief Financial OfficerPursuant to Rule 13a-14(a)/15d-14(a)

32.1       Certification of Chief Executive OfficerPursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906of the Sarbanes-Oxley Act of 2002.

32.2       Certification of Chief Financial OfficerPursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906of the Sarbanes-Oxley Act of 2002.

 

28

----

 

**SIGNATURES**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused thisregistration statement to be signed on its behalf by the undersigned thereuntoduly authorized.

 
| ** **                  | **TRINITY CAPITAL CORPORATION** |
|-----------------------------|---------------------------------|
| ** **                  | ** **                      |
| ** **                  | ** **                      |
| Date: November 9, 2005 | By:                             | /s/ WILLIAM C. ENLOE |
|                        |                            | William C. Enloe |
|                        |                            | President and Chief Executive Officer |
|                        |                            |   |
| Date: November 9, 2005 | By:                             | /s/ DANIEL R. BARTHOLOMEW |
|                        |                            | Daniel R. Bartholomew |
|                        |                            | Chief Financial Officer |

 

29

----